Felix Salmon

The Fed’s bad timing

Felix Salmon
Jun 24, 2013 15:07 UTC

If you only read one article on US monetary policy and the latest actions of the Fed, it should be Wonkblog’s interview with St Louis Fed president James Bullard — an interview that answers pretty much every question you might have, with the exception of the “why did they do this” one.

Bullard — who was the sole dissenting dove at the last FOMC meeting — released a formal statement shortly afterwards, in which he explained that he is more dovish than the rest of the committee just because inflation is significantly lower than the Fed’s target. The statement explained:

President Bullard felt that the Committee’s decision to authorize the Chairman to make an announcement of an approximate timeline for reducing the pace of asset purchases to zero was a step away from state-contingent monetary policy. President Bullard feels strongly that state-contingent monetary policy is best central bank practice, with clear support both from academic theory and from central bank experience over the last several decades. Policy actions should be undertaken to meet policy objectives, not calendar objectives.

This is clearly the message that the market received, too. While the official message from the Fed was still state-contingent rather than based on the calendar, the FOMC did deliberately choose, at this meeting, to start talking about its economic forecasts and, in doing so, to start talking about exactly when (if the forecasts hold) QE might start tapering off.

Bullard has two problems with this. The first is that monetary policy is in large part an expectations game, and a key part of monetary easing, up until now, has been a concerted effort to move away from giving guidance on when monetary policy might change in the future. Now that the dates have reappeared, says Bullard, that unambiguously constitutes “tighter policy”.

Secondly, says Bullard, one of the reasons that central bankers tend to care more about inflation than they do about unemployment is that they have more control over inflation than they do over unemployment. But right now, inflation is going in the wrong direction: it’s falling, rather than rising towards the Fed’s inflation target. So this is not the time you want to start tightening policy.

The consequences of the Fed’s statement are profound. The Fed spent years trying to get control of long-term interest rates — but we’ve just seen a rise in those rates which was so sharp and dramatic that it has taken the breath away from even hard-bitten Treasury traders. To give you an idea of how fast things are moving, Paul Krugman’s column today talks scarily about how the yield on the 10-year Treasury bond rose from 1.7% two weeks ago to 2.4%, after the FOMC meeting. But that’s print deadlines for you: this morning, the 10-year is at 2.62% and rising, while stocks are continuing to fall.

The market turmoil is bad for wealth, of course: total global stock-market losses last week were more than $1 trillion, while the US bond market has lost almost as much. But more importantly, it’s bad for growth. If you want investment capital, you’re going to be raising either equity or long-term debt. And right now the cost of both is rising sharply: in the case of debt, it has risen more than 50% in the past couple of weeks.

David Reilly tries to make the case, today, that none of this is particularly worrying. The “Bernanke put” is an unhealthy thing: the Fed’s job is not, and should not be, to support stock prices. And when it comes to debt, says Reilly, just about everybody with market access has already taken advantage of incredibly low interest rates to lock in cheap funding. “if anything,” he says, “slightly higher rates might be good if they reduce the temptation for companies to engage in financial engineering by borrowing to pay out big dividends.”

Reilly isn’t even worried about the effect of rising interest rates on the housing market: “the prospect of rising rates,” he writes, “coupled with increasing home prices, may induce more buyers to come off the sidelines.” I’m inclined to agree on that front: the connection between mortgage rates and house prices is incredibly weak.

Still, even if we grant Reilly’s point that the Fed should ignore market noise and concentrate on its mandate, the FOMC decision to start talking about implementing tighter policy doesn’t really make sense. The latest Cleveland Fed estimate of 10-year expected inflation is 1.55%, very near the all-time low, and well below the Fed’s official target. And here’s the spread between the 10-year Treasury bond and the 10-year TIPS, which gives a day-to-day indication of what the market thinks inflation is going to be over the next 10 years: as you can see, it’s been falling of late to a decidedly un-worrying level.

With unemployment nowhere near the point at which wage pressures could create inflation, both of the Fed’s mandates are still pointing strongly towards loosening (if that were possible) rather than tightening. Reilly is right that QE is going to have to end at some point. But he has no good reason to believe that weaning markets off QE tomorrow would be harder than attempting it today. The market, for one, is telling him that in no uncertain terms.


“That” vs. “Which.” I wish Felix Salmon would adopt the American style!

Posted by rmm2015 | Report as abusive

The minimum-wage stimulus

Felix Salmon
Jun 20, 2013 13:50 UTC

Nick Hanauer has a good idea today: raise the minimum wage to $15 per hour.

The minimum-wage intervention would kill a lot of birds with one stone: it’s a win-win-win-win-win-win.

First of all, most simply and most cleanly, it would immediately raise the incomes of millions of cash-strapped Americans — precisely the people who most need to be earning more than they’re making right now. A whopping 51 million people would benefit directly, along with 30 million who would benefit indirectly: these are enormous numbers.

Secondly, the cost to the government of putting billions of extra dollars into these workers’ hands would in fact be substantially negative: there’s a strong fiscal case for a $15 minimum wage. We currently spend $316 billion per year on programs designed to help the poor, with the lowest-income households receiving about $8,800 per year. Billions of those dollars would be saved as the workers in question saw their wages rise. And no longer would the likes of Walmart be able to take advantage of implicit government wage subsidies, whereby low-paid workers receive substantial top-up checks from Uncle Sam to supplement their direct income.

Thirdly, the move would constitute a huge economic stimulus program: Hanauer says that it would inject about $450 billion annually into the US economy every year. If you like massive stimulus but you don’t like the idea of the government paying for it, then a higher minimum wage is the program for you.

Fourthly, and crucially, a higher minimum wage would be good for employment. A $450 billion stimulus, delivered directly into the hands of the Americans most likely to spend it, can’t help but create jobs across the economy. Of course, as in any healthy economy, there will be a birth/death model: some employers will see demand soar, while others will see their costs rise and their margins shrink. But there’s empirical evidence to suggest that states which raise the minimum wage when unemployment is high — when there’s a lot of slack in the labor force — then you get faster job growth than in the country as a whole.

This is the particular genius of Hanauer’s suggestion: it’s especially effective right now, and we’re at the perfect point in the economic cycle to implement it. At the depths of a recession, a disruptive move like this can have unintended consequences. But the economy is growing now, albeit not as fast as anybody would like, which means the wind is behind our backs to a certain degree. The bigger economic problem is that employment hasn’t kept pace with economic growth: most of the gains in GDP have gone to capital, rather than to labor. A higher minimum wage would redress the balance somewhat.

Fifthly, insofar as a one-off hike in the minimum wage would be inflationary, that’s a good thing, and exactly what the economy needs. We’re well below the Fed’s target inflation rate right now, and the inflation which might result from this policy would give us a healthy short-term boost in the inflation rate, bringing down real interest rates in a world where the Fed is constrained by the zero lower bound. If you’re worried about the unintended consequences of heterodox monetary policy, then again, a rise in the minimum wage might be very helpful indeed in terms of weaning the Fed off QE.

Finally, there’s the global context. There are surely some US jobs which simply aren’t economic at $15 per hour, and those jobs will end up being lost. (In aggregate, as I say, raising the minimum wage is probably good for employment, but the extra jobs at employers taking advantage of all that extra spending aren’t going to be in the same places as the jobs lost at employers who can’t afford to pay that much.) But the point here is that the US has already done a spectacularly good job of exporting most of its exportable low-wage work. As Hanauer says, “virtually all of these low-wage jobs are service jobs that can neither be outsourced nor automated”. As a result, raising the minimum wage will result in many fewer job losses now than it would have done a couple of decades ago.

Of course, given Congressional dysfunction, there’s zero chance that this will happen. But I can easily imagine someone like Ben Bernanke reading Hanauer’s column and dreaming wistfully about how great it would be if we lived in a country where such things were possible. If we want economic stimulus, higher growth, higher employment, and higher inflation — which we do — then raising the minimum wage is exactly the kind of thing we should be doing.


The problem is that Felix, like a lot of people, are ivory tower folks on this. A $15 min MIGHT work in the Northeast and West Coast, but would cause catastrophic destruction in the rural Midwest and South. And, I wish anybody else who “expertly” comments on this issue would not do so until having lived in said areas themselves. (I’m assuming Felix hasn’t.)

This lack of informedness then carries elsewhere. I’ve had an Australian comment on my blog who simply doesn’t understand why this won’t work.

Posted by SocraticGadfly | Report as abusive

Why capital gains should be taxed as income

Felix Salmon
Jun 5, 2013 15:14 UTC

Last week’s Munk debate featured one of those strange-bedfellow moments, when Paul Krugman agreed with Art Laffer that the tax rate on capital gains should be the same as the tax rate on income. (In fact, Laffer went one step further than that, saying that even unrealized capital gains should be taxed at the same rate.) Normalizing the capital-gains tax rate so that it’s the same as the income-tax rate is an easy way to bring a lot of money into the public fisc — some $161 billion per year, according to the CBO. So why aren’t we doing it?

Evan Soltas does his best to answer that question with his “Defense of the Capital-Gains Loophole”. Here’s the meat of his argument:

Most tax breaks create distortions. The tax break for capital gains does the opposite: It reduces a distortion. Investment is really deferred consumption. Taxing consumption tomorrow at a higher rate than consumption today — which is what a tax on investment income does — encourages people to shift consumption forward in time, and that’s inefficient.

This doesn’t make a lot of sense. Firstly, investment really isn’t deferred consumption. The amount of money invested, in the world, is going up over the long term, not down — which means that once you look past the natural tidal movements of money in and out of various investment vehicles, it’s reasonable to say that money, once it gets invested, stays invested. Pretty much forever. The amount of money being saved, plus the amount that the investments have grown, is nearly always going to be greater, in aggregate, than the amount of money being withdrawn for the purposes of consumption. That’s the inefficient thing: money that could be cycling through the economy at high velocity is instead tied up in investment vehicles, and might not be spent for decades, if at all.

Soltas comes up with an example to show that if I invest my money today and then spend it in ten years’ time, then I’m going to end up being taxed at 50% — a higher rate than the 40% income tax. This example is a subset of the annoying dual-taxation meme. But in any case it ignores the much bigger amount of dual taxation which goes on with regard to spent money.

If I earn money and spend it today, my spending is going to become someone else’s income. If that person then pays tax on that income and spends the remainder, we’ll get yet another round of income tax out of it. And so on and so forth. It’s a constant high-velocity money-go-round, which is driving tax revenues all the way. By contrast, if my money is tied up in savings for a decade, it’s not generating any tax revenues at all. As a result, saved money generates much lower tax revenues than spent money. At the very least, then, it should be taxed at the same rate as spent money.

That said, savings do have an important role to play in the economy. Do we want to endanger that? Here’s Soltas again:

In theory, this is a strong disincentive for saving and investment, leading to less accumulation of capital and lower incomes over time. The empirical evidence is admittedly less impressive. Still, this reasoning explains why economists leant towards a preferential rate of capital-gains tax in a recent survey.

My theory is that economists lean towards a preferential rate of capital-gains tax for two reasons: they like theory over reality, and they tend to be rich people with capital gains income. The fact is that there’s really no empirical evidence to suggest that raising the capital gains tax to the income-tax rate would actually reduce savings; neither is there any good evidence to suggest that if savings were reduced, then incomes would trend lower over time. In order for the capital-gains loophole to be justified, we would need to be reasonably certain on both counts. We’re not even close to certain on either: my feeling, indeed, is that both are downright false.

Soltas does have a good point that capital-gains taxes become particularly onerous when inflation rises — an asset with zero real growth can still be subject to large capital gains if it’s held over an inflationary period. As a result, I’m open to persuasion on the idea that capital gains should be adjusted for inflation before being taxed. But the bigger picture is clear: as Soltas himself explains, “the capital-gains tax ignores investments in human capital and thereby creates a disincentive for that particular form of investment”. Unless and until Soltas can come up with what he calls “an equivalent subsidy for human capital”, we should treat all income equally for tax purposes — whether it comes from income or whether it comes from capital gains.


Debating the merits of aligning the Capital Gain tax with the income tax rates misses the point. What is really needed is comprehensive tax reform where capital gains and income taxes are part of the debate. Only then can we create a tax regimen that will address our country’s needs and be fair and balanced.

Posted by ponder | Report as abusive

Have we solved our fiscal problems?

Felix Salmon
May 15, 2013 18:00 UTC

Ezra Klein has a good summary of the latest CBO budget projections, which show that the national debt really isn’t going to be a problem at any point in the foreseeable future. The deficit isn’t going away, of course: the smallest it’s likely to get, according to the CBO, is $378 billion, or 2.1% of GDP, in 2015. But that’s entirely manageable, and puts the national debt-to-GDP ratio on a pretty flat trajectory over the medium term.

Of course, in the real world, none of this is actually going to happen as forecast. It’s hard enough to forecast what’s going to happen in 2013, let alone what’s going to happen in 2023: the CBO projection for this year’s deficit has fallen from $845 billion to $642 billion just in the past three months, so it’s worth taking all future forecasts with a large pinch of salt — especially since the one thing that’s certain is that there will be substantial changes to US fiscal policy between now and 2023.

This chart contrasts quite dramatically with the bipartisan consensus that America’s national debt — and especially the way that it is built up by the entitlement programs of Medicare, Medicaid, and Social Security — are serious problems. As Paul Krugman explains wonderfully in his latest essay for the NYRB, America’s social safety net was actually a key channel through which countercyclical government stimulus entered the economy in the wake of the financial crisis. And given how difficult it is to legislate expansionary fiscal policy on the fly, there’s a strong purely economic case for keeping such programs.

With any luck, then, this chart will help us to stop bellyaching about the debt, and create a bit of space where we can try to work out how to really get the debt-to-GDP ratio down over the long term, by concentrating on increasing the denominator rather than decreasing the numerator. But don’t hold your breath. Even the CBO takes pains to warn of debt problems in the future, saying that a debt-to-GDP ratio around 75% “would have serious negative consequences” in terms of interest expenses, lower wages, and worse:

A large debt increases the risk of a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.

In the USA, this risk is de minimis, barely even worth mentioning: not only do we print our own currency, but in general US government bonds are universally considered the safest assets on the planet. So what’s the CBO playing at, here?

Krugman has a fascinating explanation for what might be going on:

Pre-Keynesian business cycle theorists loved to dwell on the lurid excesses that take place in good times, while having relatively little to say about exactly why these give rise to bad times or what you should do when they do. Keynes reversed this priority; almost all his focus was on how economies stay depressed, and what can be done to make them less depressed.

I’d argue that Keynes was overwhelmingly right in his approach, but there’s no question that it’s an approach many people find deeply unsatisfying as an emotional matter. And so we shouldn’t find it surprising that many popular interpretations of our current troubles return, whether the authors know it or not, to the instinctive, pre-Keynesian style of dwelling on the excesses of the boom rather than on the failures of the slump.

My opinion is that it’s even simpler than that. Krugman naturally sees macroeconomic problems in terms of cycles: there are booms and busts, and there are emotional reasons why economists prefer to concentrate on the problems with booms, and apply the solutions to those problems (spend less money) even during busts where they are contraindicated.

But I think the general view of the public, and of our mainstream elected representatives, is even simpler. These people aren’t economists, and don’t think in terms of cycles; they certainly can’t clearly articulate the difference between a financial crisis and a fiscal crisis. Everything just reduces to “we spent too much, we should spend less”, which makes intuitive sense: the biggest problem with Keynes is that, just like Ricardo, a lot of what he discovered is deeply counterintuitive.

In which case, Krugman’s cyclical arguments are not going to carry the day politically: it’s hard to explain that the right thing to do changes according to various measures of resource utilization. Instead, it might be best, on a tactical political level, just to point at the CBO’s debt-to-GDP chart and say look, we’ve solved this problem now. Even if the CBO wouldn’t really agree with that interpretation.


@ Felix,

Come on man, you’re way to good a policy wonk to use the CBO forecasts unmodified. Please correct me if I’m mistaken but the baseline budget forecast assumes that:

the annual medicare fix doesn’t happen next year (as it does every year) I think that’s almost a 300B 10 year delta by itself at this point.

I think the CBO projections also assume that we’re going to drop back to only 36 weeks of unemployment insurance next year… dubious to the tune of 10 – 20 billion annually.

Also I think the earned income tax credit sunsets in 5 years which pad the back half of the forecast.

Plus we are assuming that accelerated depreciation on capital investment (which we have patched every year since 2008) ends next year.. I think that’s like 25 billion annually.

The unavoidable issue is that the standard of living for the working class in 1st world nations must continue to fall if we are wedded to the idea of a 15 year average government funded retirement. As the ratio of workers to non-workers continues to worsen taxes on workers must rise and benefits to non-workers must fall. The math is the math.

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Understanding the painfully slow jobs recovery

Felix Salmon
May 3, 2013 18:29 UTC

Today’s jobs report was a solid one, and shows that the recovery, while not exactly strong, is at least not slowing down: Neil Irwin calls it “amazingly consistent”. Whether you look at the past 1 month, 12 months, 24 months, or 36 months, you’ll see the same thing: average payrolls growth of roughly 170,000 jobs per month. That’s not enough to bring unemployment down very quickly, given the natural growth in the workforce. But unemployment is coming down slowly. And at the rate we’re going, at some point in the second half of 2014 we should see total payrolls reach their pre-crisis levels, and the headline unemployment rate hit the key 6.5% level.

There’s a real human cost to the fact that unemployment is coming down so slowly, but there are lots of reasons why it’s very hard to bring it down more quickly. First and foremost, of course, is the fact that US GDP growth is mediocre, coming in at less than 2% per year over the past few years. That’s not the kind of V-shaped recovery which creates jobs. Calculated Risk’s justly-famous jobs chart shows just how bad the recession was for employment, and just how painfully slowly we’re scratching our way back: we’re more than five years into this jobs recession, and we’re still at the worst levels seen in the wake of the dot-com bust.

One of the reasons is the undisputed conclusion of Reinhart and Rogoff: that recoveries from financial crises are much slower than recoveries from other crises. But there’s something bigger going on, too, which Joe Stiglitz writes about today in a very wonky blog post for the IMF.

This is more than just a balance sheet crisis. There is a deeper cause: The United States and Europe are going through a structural transformation. There is a structural transformation associated with the move from manufacturing to a service sector economy. Additionally, changing comparative advantages requires massive adjustments in the structure of the North Atlantic countries.

To put it another way: what looks like a broad economic recovery is actually a combination of many trends, including the end of what turned out to be a very short and weak recovery in manufacturing employment. Here’s Irwin:

The fact that the overall job growth numbers have been extraordinarily stable does not mean there isn’t some real churn going on in the U.S. workforce. In the earliest phase of the recovery, manufacturing jobs was a major driver of job creation, but that turned out to be not a longer-term trend but a partial reversal of the steep declines of the recession. Now, job creation is entirely confined to the services sector: Manufacturing had no net change in employment, construction lost 6,000 jobs, and even mining and logging was a net negative.

Government employment, meanwhile, continued its long swoon… That leaves one sector to drive the train of job creation: private sector services. This particular month, there were strong gains in leisure and hospitality, retail jobs, and professional and business services, and health care has been a mainstay of the expansion.

Stiglitz makes the case that in a recovery with so many moving parts, the single blunt instrument of setting short-term interest rates at the Fed will never be enough, and that “there needs to be close coordination between monetary and fiscal policy.”

What’s more, as Mohamed El-Erian says, policymakers should ideally be able to use job growth not just as a goal, but also as a tool for achieving other ends.

Robust employment growth would – and, let us hope, will – play a critical role in helping the US pivot to a better place… It would do this by maintaining consumption and allowing for a more sustainable savings rate; by countering an excessive upfront fall in public spending that increases the risk of a recession; by enabling the Fed to slowly and gradually normalise monetary policy before it breaks too many things; and by reducing the risk of financial bubbles.

The US economy is a highly complex machine, with many moving parts which ought to be working with each other rather than against each other. Stiglitz makes a strong case that the financial sector broadly is right now part of the problem rather than part of the solution: it’s not directing funding to help the economy grow and create jobs, even as it continues to represent a serious systemic risk. It should go without saying at this point that fiscal policy broadly is part of the problem as well: you don’t create jobs by firing people, and the government should be borrowing if and when the private sector won’t. And as for monetary policy — well, it’s probably too early to tell. It’s done a great job of making people with money richer, but it has had a much less obvious effect on creating jobs for those who want them and don’t have them.

And yet there’s real room for optimism in today’s jobs report. Look at the revised numbers for February: an incredibly heartening 332,000 jobs created, in one short month. Look at the number of people unemployed for 27 weeks or more: that unhappy cohort shrank by 5.6% in April alone, to 4.3 million people. It’s still far too high, but this time last year it was over 5 million, so we’re making a significant dent in what has been the toughest nut to crack.

We can — and should, and could, and must — do better than this. But doing so will require a thaw in the Washington gridlock. When Jack Lew became Treasury secretary, it was understood that the most crucial thing he could deliver would be greater cooperation between the White House, Treasury, and Capitol Hill. That hasn’t happened yet. I hope and trust that he’s been working very hard behind the scenes to make it happen — partly because he doesn’t seem to have achieved anything else, but mainly because it’s by far the most important thing that he could be doing right now. Behind the jobs numbers there are some powerful forces driving real recovery in large parts of the US economy. It’s Lew’s job to work with Congress to identify those forces, and to give them all the support the government can muster.


It is really disappointing to see all this commentary and no mention of 1) China and 2) predatory capitalism. There are two causes of the declining role of employment in our economy: outsourcing to lower wage geographies and a persistent culture of cutting all FTEs from corporations. The Great Recession merely accelerated these trends and legitimated massive cost cutting across all corporations in the US.

There really is no end to these trends. We would need a complete reengineering of the motivations of businesses and governmental policies to even slow down these trends. And note that not a single politician is wlling to tackle either one of these monsters.

Posted by Dollared | Report as abusive

Chart of the day, reverse-causality edition

Felix Salmon
Apr 18, 2013 03:22 UTC

This chart comes from Arindrajit Dube, who has a fantastic post chez Rortybomb on whether high debt causes lower growth or whether it’s the other way around. What you’re looking at is the famous Reinhart-Rogoff dataset, as made available by their critics (and Dube’s colleagues), Herndon, Ash and Pollin. Reinhart and Rogoff are the poster children for the statement that high debt loads cause lower growth, especially once those debt loads exceed 90%. But do they?

There does seem to be an inverse correlation between debt and growth, but Dube shows that the correlation is strongest at low levels of debt, below 30% of GDP, rather than at high levels of debt. Countries with debt of 30% of GDP have a significantly lower growth rate, on average, than countries with debt of 10% of GDP, while the numbers at debt ratios above 90% have much wider error bars and are much less useful.

But let’s grand the correlation, for the sake of argument: the next question is whether the correlation implies causation, and if so, which way the causation flows. Here’s Dube:

Here is a simple question: does a high debt-to-GDP ratio better predict future growth rates, or past ones? If the former is true, it would be consistent with the argument that higher debt levels cause growth to fall. On the other hand, if higher debt “predicts” past growth, that is a signature of reverse causality.

That’s what you’re seeing in the charts. Both of them have the same axes: GDP growth on the y-axis, and debt/GDP on the x-axis. Both of them plot the correlations in the dataset, with the dark line being the signal and the dotted lines showing the 95% confidence interval. And just as in the main dataset, the correlations are much clearer at low levels of debt/GDP than they are at higher levels.

But the two charts are different, all the same, especially at levels of debt/GDP above that 90% level. If you look at the left-hand chart, it shows that it really doesn’t matter how much debt you have: you’re likely to average about 3% GDP growth a year over the next three years. On the other hand, if you look at the right-hand chart, it shows that the more debt you have, you’re significantly more likely to have experienced low growth in the past three years.

In other words, the causation here seems about as clear as causal analysis can ever be: low growth causes high debt, rather than high debt causing low growth. Indeed, once you get past 90% of GDP, your debt load doesn’t seem to have any significant effect on future growth at all!


It makes perfect sense that higher debt would cause slower growth. It also makes sense that slower growth causes higher debt. The data bear both out to be true. The idea that only one can be true is a false paradigm.

Your analysis shows that “>90% debt level hardy effects growth”. A ridiculous result should cause you to take a more careful look.

I suspect that the analysis is flawed because nations whoutout a strong economic base and tradition tend to not be able to extend their borrowing much beyond 90%. For example, the US may be able to achieve a 200% debt level, while Greece has a crisis at 125%. Data from Greece will thus never be represented on the right side of those graphs.

It is also likely that the majority of the astronomical debt levels on the right side of those graphs represented debt accumulated during each world war. Reinhart-Rogoff concluded that war debt did not have as strong negative effect on growth. That makes your left graph consistant with their findings.

Posted by Kennen | Report as abusive

Britain’s fiscal failure

Felix Salmon
Mar 13, 2013 16:22 UTC

Never mind Sachs vs Krugman: by far the most interesting and important fiscal-policy debate right now is Cameron vs Wolf.

David Cameron, of course, is the prime minister of the UK, and last week he gave a rambling 4,000-word speech on the national economy which is almost impossible to read. For some reason the speech appears online in what you might call teleprompter format, with a single sentence sometimes spanning three separate paragraphs. It’s a clear indication that Cameron is more interested in rhetoric than he is in substance.

Meanwhile, Martin Wolf, who for many years has been the most respected and important economic commentator in Europe, has in recent weeks become much more accessible. Check out his column on bankers’ bonuses, for instance: it’s a smart and rollicking read, arguing persuasively that the UK government is being idiotic in its opposition to European bonus caps.

Wolf’s immediate response to Cameron was solid, but his second go-round is just devastating: we’re now officially in a world where the wonkiest columnist in the driest newspaper in Britain is stating his case far more simply and clearly than the populist PR man turned prime minister:

Mr Cameron argues that those who think the government can borrow more “think there’s some magic money tree. Well, let me tell you a plain truth: there isn’t.” This is quite wrong. First, there is a money tree, called the Bank of England, which has created £375bn to finance its asset purchases. Second, like other solvent institutions, governments can borrow.

Wolf’s main point is simple: in an economy which might already be in a triple-dip recession, deficits are caused by economic sluggishness. That’s what forces up government spending while reducing government revenues. Everything comes back to growth: the UK credit rating, the size of the deficit, and, most simply, nominal GDP, which is now 13.6% lower than the government officially forecast it would be back in 2008.

What’s more, government spending comprises a much larger share of GDP in the UK than it does in the US, which means that spending cuts can easily directly cause recessions. And deficits always go up, rather than down, in recessions:

The prime minister also stated: “[Labour] think that by borrowing more they would miraculously end up borrowing less … Yes, it really is as incredible as that.” What truly is incredible is that Mr Cameron cannot understand that, if an entity that spends close to half of gross domestic product retrenches as the private sector is also retrenching, the decline in overall output may be so large that its finances end up worse than when it started. Bradford DeLong of Berkeley and Larry Summers, the former US Treasury secretary, have shown that, in a depressed economy, what Mr Cameron deems incredible is likely to be true.

Cameron’s speech is basically the horrible personal-finance metaphor writ large: he’s trying to persuade people that solutions which make sense on a household-budgeting level can scale up to the national-accounts level. He’s obviously never heard of the paradox of thrift.

In fact, the speech is even more confused than that. At the beginning of the speech, Cameron attacks the policies of politicians who thought “that we had ended boom and bust”. Obviously, we haven’t. But then he makes no attempt at all to explain what government policy should be during boom years, and how that policy should differ during recessions. And finally he gets into the thicket of monetary policy, explaining that he essentially needs to abolish boom and bust himself, else none of his policies are going to work.

Cameron boasts in the speech that “it is now possible to buy a new home anywhere in the country with only a 5% deposit, and at very low interest rates,” and worries that “even just a 1 per cent rise in mortgage interest rates would cost the average family £1,000 in extra debt service payments”. He then says (the ellipses are his, not mine):

It is hard to overstate the fundamental importance of low interest rates for an economy as indebted as ours…

…and the unthinkable damage that a sharp rise in interest rates would do.

When you’ve got a mountain of private sector debt, built up during the boom…

…low interest rates mean indebted businesses and families don’t have to spend every spare pound just paying their interest bills.

In this way, low interest rates mean more money to spare to invest for the future.

A sharp rise in interest rates – as has happened in other countries which lost the world’s confidence – would put all this at risk…

…with more businesses going bust and more families losing their homes.

In other words, Cameron is placing all his chips on permanently low interest rates, which are the one thing he can’t control. And at the same time, he’s pursuing a contractionary fiscal policy, which is the main thing he can control. Here’s Wolf, explaining elegantly just how confused the prime minister’s thinking is:

As the prime minister himself notes, “we had over-indebted households borrowing from over-indebted banks”. So why does he expect monetary policy to achieve much? He evidently thinks people should borrow less…

Today, even more aggressive monetary policy is quite likely to be ineffective, even counterproductive, to the extent that it slows desirable deleveraging. It is likely that direct monetary financing of even larger fiscal deficits would be more effective and less damaging than using even looser monetary policy to prod the private sector into life.

This is the political mess that Mark Carney is inheriting as he takes over the Bank of England. The prime minister is betting everything on low interest rates and on loose monetary policy, while using fiscal policy to make Carney’s job as difficult as possible.

The UK is in a very tough economic spot right now, and it needs coordinated fiscal and monetary policy to get itself growing again. But the leader of the Conservatives seems to relish the idea of doing nothing at all on the fiscal side, while the leader of the Bank of England only took the job after deciding that he wouldn’t run for leader of the left-wing Liberal party in Canada. The chances of these two working effectively together seem slim indeed — and as a result, the future’s looking pretty bleak for Britain.

Update: Wolf’s colleague Chris Giles pushes back.


Good points, QCIC.

I think we are closer to the 30′s (perhaps 1937) than to the 90′s. Let’s hope the next decade works out better this time around…

And agree totally on “chasing growth”. If you pay people to dig holes and fill them in again, you’ve increased the GDP without any real increase in productivity. This is effectively what we were doing in both the tech bubble and mortgage bubble. We haven’t had a healthy domestic economy since the 1980s, and that shows when you look at middle-class paychecks.

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Why fiscal problems don’t have fiscal solutions

Felix Salmon
Mar 6, 2013 15:40 UTC

The main lesson I’ve learned from the sequester fustercluck, and from the failure of austerity programs in Europe, is that you can steer yourself very, very wrong indeed if you try to find fiscal solutions to fiscal problems.

The two phenomena are different: the stated aim of the sequester was to focus attention on long-term fiscal problems, while European austerity is generally targeted much more at the short term. But both resulted in the same thing: governments cutting their spending and hurting growth, when growth is the only real solution to the problem at hand.

In Europe, the key short-term problem is unemployment; in the US, the long-term problem is America’s ability to pay its scarily-rising healthcare costs. In neither case do government budget cuts do anything whatsoever to address the problem; instead, they exacerbate it.

Unemployment is the more obvious case: if the government lays off thousands of workers, and stops injecting money into the economy through other channels, that’s never going to help people find work in the short term. But the case against a fiscal solution to the healthcare-cost problem is also a pretty simple one. Here’s John Carney:

The main challenge we face on entitlements is not financial — it’s demographic. It’s not really even a question of “entitlements” at all. The challenge is just whether the economy in the future will be productive enough to produce all the medical care, food, and shelter required by the elderly when there are fewer people actually working. How we pay for this is secondary matter.

To put it differently, no matter what budget reforms we enact, we have a long-term care problem — not a long-term deficit problem. Even if we dramatically cut down on the long-term deficit by slashing entitlement spending, so that any care in excess of that has to be funded privately, we’ll still face the same challenge.

That challenge cannot really be solved through budgets. No matter how much we tax now, no matter how much we save now, in the future the economy will be limited to what it is able to produce. The challenge is to set that limit as high as possible, so there is as much as possible for the young and the old to divide it among themselves.

Put aside, for one minute, the question of whether marginal discretionary government spending is good or bad for economic growth; the point here is that the problem of healthcare costs isn’t fiscal. Indeed, it’s easy to go even further than that, and to say that the more money the government spends on healthcare, the smaller that the problem of healthcare costs becomes. After all, everywhere in the world, including in the US, the government gets by far the best price in the market when it spends money on healthcare. If you switch healthcare expenditures from the public sector to the private sector, all you do is make them more expensive.

And as Joe Weisenthal points out, quoting Richard Koo, the more that a government worries about long-term fiscal balance, the less effective it becomes in attempting to stimulate the economy to provide the kind of growth that everybody wants to maximize. Just look across the Pacific, says Koo: Japan has never once met its fiscal targets in the past 20 years, precisely because it has been consistently far too worried about meeting its medium-term fiscal targets.

The solution to all these problems has to be to maximize the number of people with jobs; to maximize the amount of money those jobs pay; and to maximize the number of years that people are earning money in those jobs. Eduardo Porter, today, makes the case for raising the retirement age, which of course would reduce the increase in Social Security costs. But he also makes the point that if people stay in well-paying jobs for longer, that benefits the entire economy — which in turn will improve our ability to provide America’s seniors with the healthcare they deserve.

Meanwhile, the rhetoric of the sequester is making everybody look in exactly the wrong place for solutions to America’s long-term fiscal problems. The amount that the government spends on national parks, or on FBI salaries, or even on mine-resistant, ambush-protected Army vehicles, is of course irrelevant to the question of how to create an economy which can afford medical care for all over the long term. But it also creates a framing problem — making it seem as though government expenditures are the nail, and that therefore budget cuts are the necessary hammer. Even as, all the while, the deep and real problems become that much more structural, embedded, and intractable.


@Fifth, I would like to recommend the following article to your attention — it puts my position better than I ever could myself:

http://www.huffingtonpost.com/jeffrey-sa chs/professor-krugman-and-cru_b_2845773. html

I could and would support a long-term program of spending on infrastructure, education, and public well-being. Unfortunately economists have convinced themselves that it doesn’t matter what the money is spent on — paying people to dig holes and fill them in again is equivalent to paying people to build things that will last for generations. That is obviously false!

Will also note that union rules and corporate profiteering make it exceptionally expensive for the federal government to invest in the future. Federal sector wages/benefits are $10/hr higher than for comparable private sector jobs according to the CBO. I could imagine hiring legions of unemployed at $30k/year to build, clean, landscape, and care for the nation and its citizens. But paying federal wages/benefits of $100k/year, that is no longer financially feasible.

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When the finance minister targets stock prices

Felix Salmon
Feb 11, 2013 15:55 UTC

Japan’s economy has been far too stagnant for far too long: everybody can agree on that. The aging population, now used to deflation, prefers saving to spending — an entirely reasonable stance if prices will be lower tomorrow than they are today. So the government has long been facing a very tough task: to change the psychology of a nation, basically. You can’t do that — as Japan learned the hard way — with old-fashioned public-works spending. Instead, you have to target expectations.

The Bank of Japan started on this road last month, formally adopting a 2% inflation target. That was the BoJ’s way of saying “start spending now, because your yen won’t be worth as much tomorrow as they are today”. And now the finance minister is doing his part to get the party started as well, in a highly unorthodox manner. In a speech on Saturday, he said that he wants to see the Japanese stock market rise 17% to 13,000 by the end of March.

It was a national holiday in Japan today, so the stock market was closed, but we’ll see tomorrow what effect Amari-san’s words will have: my guess is that they’ll give the market a pretty impressive boost. That’s certainly the intention. The Japanese stock market has been on fire of late, rising more than 30% since mid-November. The clear risk is that the rally will lose steam, and that people will start taking profits; the finance minister, with his speech, is basically trying to extend the rally as much as possible.

There’s no particular reason why the Nikkei shouldn’t continue to rise through the end of March, even reaching 13,000. Momentum is a powerful force, in the stock market, which is why central banks know that FX intervention is much more likely to work if you’re acting broadly with the market rather than broadly against it. Amari’s announcement is a canny way of anchoring expectations: the Nikkei might reach 13,000, or it might not, but for the next few weeks at least the perennial stock-market question is going to be reframed. Rather than “how far are we from where we closed yesterday”, it’s going to be “how far are we from 13,000″. The idea is that with stocks, just like with cars, you generally drive in the direction you’re looking.

I like this move: it shows imagination, and the upside is much bigger than the downside. The worst that can happen is that it doesn’t work, and the stock market ends up doing what the stock market would have done anyway; the best that can happen is that it helps accelerate the broad recovery that everybody in Japan is hoping for this year.

What’s more, Amari is not the first policymaker to talk about targeting asset prices. Minneapolis Fed president Narayana Kocherlakota, for instance, said quite clearly in 2011 that stock prices “are really going to be a central ingredient in the recovery process”, adding:

In this kind of post financial crisis, post net worth driven recession, it makes sense to be thinking about asset value as a way to try to generate more stimulus than you do in a typical recession.

In other words, don’t look to government spending for stimulus: Japan, of course, has learned that lesson the hard way. Instead, simply goose the stock market instead.

There are risks to this approach: if it works too well, you create a bubble — and when a bubble bursts, that can hurt confidence much more than a rising stock market helped it. But for the time being, the Japanese stock market still looks cheap, both on an absolute basis and in terms of its p/e ratio. Now’s no time to worry about overheating. Instead, Japan’s fiscal and monetary policymakers are working together to try to make the country as bullish and successful as possible. I’d do the same thing, if I were them.

(h/t BI)


The (oft-repeated) view in the first paragraph is based on a dated view of Japanese households that is no longer accurate.

Japan’s household savings rate has fallen steadily from from well over 10% of disposable income in the mid-1990s down to around 2-3% of disposable income for the past several years.

http://www.oecd-ilibrary.org/sites/factb ook-2011-en/03/02/03/03-02-03-g1.html?co ntentType=&itemId=/content/chapter/factb ook-2011-22-en&containerItemId=/content/ serial/18147364&accessItemIds=&mimeType= text/html


http://www.gfmag.com/tools/global-databa se/economic-data/12065-household-saving- rates.html#axzz2KcPoI59k

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