Lynx, and a comment about the political non-costs of fiscal recklessness.

February 16th, 2018 at 11:59 am

I’m not exactly sure which links I’ve put here already, but I’ve been busy (there is the possibility that if you can’t remember what you’ve been writing, you’re either writing too much or getting too old; I know the latter is true; not sure re former).

WaPo PostEverything Posts:

There’s a leaked proposed rule from team Trump that expands the definition of “public charge cases,” wherein immigration status is threatened by use or expected use of public benefits. Here’s why the daft draft rule is destructive and counterproductive. My intuition is that it won’t block people from coming here; it will lead to disinvestment in them and their kids once they’re here.

Yes, inflation and interest rates are definitely picking themselves up off the mat. That’s a good and expected development at this point in the cycle. Do not confuse heating with overheating.

One profound challenge we face in gauging economic capacity is that economists cannot identify the lowest unemployment rate consistent with stable inflation or the level of GDP at full potential.

Unless we’re willing to put new revenues on the table, deficits and debt will only continue to grow.

Here’s a fun episode of The Indicator, one of my favorite, new podcasts, wherein I explain how I ambivalently welcome that the current slug of stimulus. Yesterday, I listened to about five of these episodes in a row–they’re short–and I gotta tell you: huge bang-for-buck in terms of engaging and even entertaining info/minute.

Sticking with fiscal policy, Paul K has a column up today wherein he appropriately excoriates the hypocrisy of Republicans on their transparently phony fiscal rectitude, along with self-identified “centrists” who have, in their play to appear balanced, long refused to recognize the truth that these alleged fiscal hawks are and have always been chicken hawks. The deficit matters to them if and only if it can referenced to a) block Democratic spending initiatives, and b) leverage cuts to any government program that doesn’t redistribute income toward their donors.

If I may add an editorial comment outside my econ zone, consider conservatives’ indifference to debt (tax cuts), the safety net (Trump budget), and gun control. These policymakers should never be allowed to say another word about their concerns for children or future generations. Their actions completely belie any such claims.

But the point I wanted to add to Paul’s piece is a political economy one. Politicians have never paid a price for adding to the debt. To the contrary, George HW Bush paid a price for raising taxes to try to do something about red ink. One reason for this political non-cost is that all that deficit spending has not had the negative impacts economists’ typically claim.

A voter might vote against a politician who raised taxes or opposed abortion rights or was hostile to immigration. These are all very clear positions. But, based on the empirical record, our voter can be wholly forgiven for discounting arguments about the impact of public debt on interest rates, growth, and jobs.

I’ve argued that, in fact, deficits do matter. In weak economies, we often need them to be larger than they are, but as we close in on full employment, we generally want fiscal gaps to close (though listen to my Indicator interview above for some nuance re the current moment).

I’ve got four reasons:

Political reasons: it’s a lot harder to sustain support for programs that are deficit funded;

Fiscal reasons: any spike in interest rates is more expensive at high public debt levels than low ones;

Recessionary reasons: though there’s not much of an economic rationale for it, it’s clear that policymakers will apply less fiscal policy to offset recessions at low vs. high fiscal space;

Economic reasons: though we haven’t seen it for decades, if the economy is already at capacity, it’s likely that deficit spending will generate not jobs or growth, but just higher inflation and interest rates.

When you consider the politics, it may only be the first and last reasons that catch voters attention. If higher deficits can clearly be linked to economic hardship voters are experiencing or the loss of programs they value, those voters may discipline fiscally reckless policy makers.

But that’s just a conjecture on my part. There must be someone out there who has cast a vote against a politician based on their fiscal recklessness, but I’ve never met them.

The President’s new budget. Sorry, but attention must be paid.

February 12th, 2018 at 4:32 pm

Every year around this time, we ask the Talmudic question: is there any reason to pay attention to the president’s budget?

This year, given that the Congress just passed, and President Trump just signed, a spending deal covering the next couple of years, the question is particularly germane, as “dead on arrival” would be an upgrade for this year’s budget.

And yet, I once again conclude that attention must be paid. People should know an administration’s priorities, but in the case of team Trump, as the gulf between their rhetoric and their budget preferences is uniquely wide, tracking their priorities is particularly important. They make a huge deal over infrastructure but cut transportation funds; they talk about helping the left-behind but propose cuts to health care, nutritional assistance, and housing. They preach fiscal rectitude but practice fiscal recklessness.

In this regard, the basic structure of Trump’s second budget is closely related to those Republicans have been writing for years, reflecting their shared priorities of tax cuts for the wealthy and spending cuts for the economically vulnerable.

For example, according to CBPP analysis, the budget takes us back to the big health care debate of last year, calling for repealing the Affordable Care Act, cutting Medicaid, and eliminating protections for people with pre-existing conditions. It proposes cuts in nutrition, housing, and other basic assistance for millions of vulnerable Americans. For example, SNAP (formerly food stamps) would face a $213 billion, or a nearly 30 percent cut over ten years; at least 4 million low-income people would lose their SNAP benefits altogether.

Regarding infrastructure, do not—I repeat, do not—take seriously the claim that there’s a plan here to invest $1.5 trillion in our public goods. Far, far from it. The budget proposes $200 billion over 10 years, but as budget analyst Bobby Kogan tweeted: “The budget cuts $178 billion in…transportation [not including cuts to] water, broadband…and energy. This means [Trump is] giving $200 billion with his left hand but taking away that much with his right.”

In fact, the “plan” depends on shifting the costs of infrastructure investment to private investors, states, and cities. Regarding the states’ ability to fund infrastructure, there’s a critical interaction with the Trump tax cut to consider. Recall that the plan significant lowers the amount of federal taxes that state and local taxpayers can deduct from their tax bill. This change will make it much harder for states and cities to raise the revenue to support this sort of infrastructure plan. As I recently wrote on this topic, “Trump and the Republicans are shifting infrastructure costs to the states at the same time they’re cutting the states’ revenue-raising capacity off at the knees.”

One thing to watch is the extent to which the budget violates the terms of the bipartisan spending plan Trump just signed. Remember, at this point, a lot of that spending is just topline amounts, yet to be allocated to specific spending lines. Nudged on by this budget, which sets funding for Democratic priorities from the deal $57 billion below the agreed-upon levels, conservatives will try to chip away at non-defense allocations to education and worker training, medical research, transportation, low-income housing, environmental protection, the national parks, child care, and more.

For example, CBPP points out that “the bipartisan agreement calls for adding $2.9 billion per year over the next two years to the discretionary Child Care and Development Block Grant, boosting this key federal program to help make child care affordable for low- and modest-income parents. But the budget reneges on that and proposes essentially flat funding for the program.”

Again, I don’t think Congress will violate the new agreement, but there’s no question the president’s budget dials up the pressure to re-open the deal at the expense of programs in those areas.

Here’s one area where the budget reveals serious damage that’s already been done to government under Trump’s watch. As the Wall St. Journal’s Richard Rubin put it, “A big result of President Donald Trump’s tax cuts is a predictable one: Less revenue for the federal government.” Even using the administration’s own rosy economic scenario, projected revenue is down 6 percent from their last budget.”

In 2019, they predict revenues as a share of GDP to be 16.3 percent. What’s alarming about that number is that it’s projected to occur in a period when the economy is at, or at least near, full employment. In such periods, the percolating economy should be spinning off increasing revenues as a share of GDP, as more people make more money and pass into higher tax brackets. Using data back to the 1960s, when the unemployment rate has been around where it is now—in the 4 percent range—revenues have come to about 18 percent of GDP. In today’s economy, that difference of two percentage points (16 vs. 18) of GDP amounts to $400 billion per year in revenues lost to the tax cuts.

Of course, that’s a feature, not a bug, for those in the starve-the-beast camp. But as I argued the other day, with the recent spending bill as exhibit A, it doesn’t work that way. Once they whack the tax base and take new revenues off the table, the beast doesn’t starve. It gets fed in deficit dollars.

The media is probably one or two crazy tweets away from never mentioning this budget again, and I certainly understand that in terms of news value. But it is incumbent on those of us who recognize what Trump and the Congressional Republicans are up to, to call them out.

And what is it that they’re up to? Channeling revenue from the Treasury to the wealthy, while trying to convince the public that America’s problem is not inequality, dysfunctional government, disinvestment in physical and human capital, and an increasingly non-representative democracy. Instead, their budget implies that what’s holding America back are poor people getting $1.40 a meal in nutritional assistance, or a family whose housing assistance and Medicaid allows them to get by on a minimum wage job.

Immediate political salience aside, anytime that demonstrably false argument is made, it must be highly elevated and thoroughly rejected.

The new asymmetric risk

February 9th, 2018 at 2:03 pm

For years, economists, including no less than former Fed chair Janet Yellen, talked about the concept of “asymmetric risk,” or AR. In this earlier context, which related to monetary policy, AR maintained that the risk of weak demand was greater than that of faster inflation. Therefore, the full-employment side of the Fed’s mandate should get more weight in interest rate decisions than the stable-prices part.

With some important caveats I’ll get to below, there’s a new AR in town, this time as regards fiscal policy. As I’ve written in many places, thanks to the deficit-financed tax cuts and new spending bill, the deficit as a share of GDP is going to be unusually large, given that we’re likely closing in on full employment.

As John Cassidy points out, some analysts, quite reasonably, worry that stimulating an economy so close to full employment is a basic economic mistake. It’s being more Keynesian than Keynes. Such stimulus won’t deliver more real economic activity, like jobs or real wage growth. It will just deliver more inflation and higher interest rates, which we slow growth. Added fiscal impulse at this point, they fear, will add more heat than light.

I share their concerns, but I think AR is in play, which points towards supporting this fiscal experiment. Once again, the risk of insufficient aggregate demand is greater than that of overheating. Let me explain.

You may be thinking: “insufficient demand!? But the economy is clearly at full utilization!”

Here’s the thing about that: neither you nor I know that to be the case. The first figure below shows that it is beyond our ability to identify the lowest unemployment rate commensurate with stable inflation. The next figure is trickier but it’s explained in this important new paper from our Full Employment Project that recalculates potential GDP, or GDP at full utilization. The thick, bottom line is actual GDP relative to its 2007 level and the middle clump of lines are the relevant re-estimates, using an arguably better technique. They show that there’s maybe 5 percent of GDP more untapped capacity than the conventional wisdom suggests.

Forthcoming, Bernstein, 2018.

Source: Coibion et al.

Meanwhile, inflation, which is the main risk of overheating, has been too low for too long. The Fed has missed its 2 percent inflation target to the downside for years running.

Ergo, given that we cannot confidently assert that we are at full employment or full capacity, that there are still people left behind, that wage trends and employment rates for some groups of workers are still on the mend, that inflation remains low and below target, and that if it did speed up, the Fed has ample room to hit the brakes, this hyper-Keynesian experiment is worth undertaking.

OK, caveat time, and there are good ones which I take seriously.

–It’s not just faster inflation we should worry about. It’s also higher interest rates, which could slow down growth and hurt the real variables we care about. As debt investors sniff wage and price pressures, they’ve insisted on higher inflation premiums. As I write, the yield on the 10-year Treasury is up about 40 basis points this year, at about a 4-year high. For years, the evidence for bigger deficits nudging up interest rates was nowhere to be seen. But that could be changing, and if so, the AR becomes less A and more balanced.

–This particular fiscal stimulus has lousy multipliers. Some of the spending in the budget deal may end up supporting useful infrastructure projects and providing much needed disaster relief—worthy expenditures that could help tighten the job market in places where it’s still slack. But the regressive tax cut is terribly targeted, and any fiscal stimulus is less potent when the Fed is pushing in the other direction, albeit slowly. So even if the AR scenario is correct, the bang-for-the-buck here is sure to be weak.

–Even if this AR scenario is in play this year, it may not be next year. The fiscal impulse from all this spending is, by some estimates, about the same both this year and next (Alec Phillips at Goldman Sachs finds that the growth impact should be about an extra 0.7 percentage points in 2018 and 0.6 points in 2019; no link). So, if added fiscal impulse doesn’t trigger overheating in 2018, it could do so in 2019.

In sum, asymmetric risk doesn’t mean no risk. And given the unusual, pro-cyclical timing of all this spending and tax cuts, the risks engendered by these fiscal dynamics are unquestionably worth watching out for. But if this extra spending can knock the unemployment rate down to the mid-3’s by the end of this year without triggering more than the expected and manageable amount of price and rate pressures, then, from the perspective of those who’ve yet to benefit from full employment, it will be worth it.

Links and a musical interlude from the Professor

February 9th, 2018 at 12:12 pm

First, here’s a post at WaPo wherein I point out that as long as new tax revenues remain off the table, then we’re implicitly agreeing to ever-higher deficits and debt.

Here’s another one on how we shouldn’t let the prevailing fiscal dynamics tie us up in knots.

And, far better than the above, here’s Professor Longhair telling the fabled tale of poor old Junco Partner, a dude who drank a bit too much and ended “wobblin’ all over the street.”

This moment in deficit spending

February 8th, 2018 at 12:04 pm

There’s an interesting argument in play right now as to whether current deficit spending is welcomed or problematic, and what its impact might be. The motivation for the argument is the deficit financing of the tax cut and the new budget deal (which adds at least $300-$400 billion to the debt over the next decade), particularly at a time when the economy is closing in on full employment. As I recently pointed out, deficits of around 4-6% of GDP, which is what we’re probably looking at over the next few years, are highly unusual at such low unemployment. On average, going back many decades, the deficit/GDP at such low unemployment has hovered around zero.

The figure below makes the point:

Source: Alec Phillips, GS Research

The figure is a little tricky, because the unemployment rate is inverted, meaning when the line goes up, unemployment’s going down. The reason to do it that way is to show how closely linked the jobless rate usually is with the def/GDP.

“These are both highly cyclical variables. When unemployment goes up a lot, the deficit tends to go up as well, as various “countercyclical” spending programs kick in, while tax revenue take a hit. So, outside of wars, when deficit spending goes up for noneconomic reasons, the two lines hug each other pretty tightly.

Until recently. The timing of the tax cuts [and now the budget deal] is such that they’re throwing a lot of fiscal stimulus—hundreds of billions in new, deficit spending—at an economy that’s already, on its own, closing in on full employment. Based on the already strong, negative trend in the unemployment rate, and the added stimulus, the unemployment rate could be in the mid-3s by the end of this year (it’s currently 4.1 percent). That’s a jobless rate we haven’t seen since the late 1960s.”

That’s the backdrop for the argument. The participants fall into these camps (there are other camps, I’m sure, but these are the ones of interest to me today):

–Political deficit-chicken-hawks. These are politicians who whine about deficit spending but that’s largely for show. Since I’m trying to get into the substance of the argument, this post isn’t about them. There are good questions about whether their hypocrisy costs them anything, politically, but that’s for a later day.

–Actual deficit hawks. Folks like my friends at the CRFB who are genuinely concerned about the impact of all this debt on government functionality and future generations.

–Keynesian types who think we’re not yet at full employment. Let’s call them NYFE’s (Not Yet Full Emp).

–Keynesian types who think we are at full employment. Let’s call them FEs.

Though our views intersect here and there, I tend not to share the concerns of the actual hawks, and I worry their arguments feed a damaging austerity agenda. It’s possible to be so focused on the future that you shortchange the present. That said, where we come together is a) deficits should generally come down, not rise, as you close in on full employment, and b) as I wrote in another piece this morning, it’s very hard to lastingly sustain and defend programs that are deficit, versus revenue, financed.

A related argument to that of the true hawks, one with which I couldn’t agree more strongly, is that not all deficit spending is created equal, and the revenue losses in the tax plan and some (not all) of the spending in the new budget deal are wasteful and terribly targeted. I’ve argued this in many other places.

But it’s the FEs and the NYFEs that interest me most. The NYFEs, among which I count myself, believe that there’s still some amount of slack in the current economy, and that those 4-6% deficits/GDPs over the next couple of years could create a high-pressure economy with more benefits than costs, especially to the least advantaged who are, in the age of inequality, the last to participate in the expansion. In fact, they’re LIFO–last in, first out–the benefits of growth take the longest to reach them but they’re the first to get smacked by the downturn.

Evidence? The NYFEs best evidence by far is inflation, which remains low and stable, despite much angst in recent days. Some measures of inflation expectations are showing an uptick, especially market-based measures, like TIPs breakeven rates and especially the 5-yr/5-yr forward inflation expectation rate. But survey measures haven’t yet turned up as much as the market measures, and the market measures are not pure expectation metrics; research finds they also mix in inflation premiums demanded by lenders and other short-term, volatile price pressures, like the ups-and-downs in oil prices.

Also, there’s no question in my mind that we cannot identify, within policy relevant confidence intervals, either the “natural rate” of unemployment–the lowest rate consistent with stable prices–or the level of potential GDP to shoot for (the level of GDP consistent with full resource utilization). On this latter point, I was moved by this smart, new paper by Coibion et al recently published by our Full Employment Project, showing estimates of potential that are well north of the conventional wisdom. See also the note by economist Olivier Blanchard, who’s sympathetic to the findings and particularly, the inflation point.

On the “we-can’t-identify-the-full-employment-unemployment-rate” point, see the figure below from a forthcoming paper I wrote, soon to be published by the Brookings’ Hamilton Project, on ways to get to and stay at full employment. (I’m excited about this paper, if one can say that about their own work, but I think it’s OK in this case because I got a lot of great input from others; this figure is from an ERP from a few years ago. so I’m not scooping anything.) It shows the confidence interval around estimates of the “natural rate” literally exploding (well, not literally…).

Forthcoming, later this month.

In sum, while we NYFEs hate the targeting of the tax cut–corporate tax cuts, tax goodies to rich heirs and high-end pass-throughs are terrible forms of stimulus with a weak bang-for-the-buck–we think there’s still slack in the job market (I didn’t get into prime-age employment rates and wage trends, but they also arguably provide support to the NYFE’s case). I’ve suggested that if the Fed accommodates, the jobless rate could hit the mid-3’s by the end of this year. At that point, I believe the benefits of full employment would be much more widely felt than they are now.

The position of the FE’s is easiest to explain with an arcane diagram, borrowed from no less than Paul Krugman, who has used it make accurate predictions since the downturn, so it’s got some street cred. It’s the old ISLM workhorse, a bare-bones representation of how interest rates and output interact in the macroeconomy, drawn here with a key wrinkle. The flat part of the curve, in this context, just means that under certain conditions, extra fiscal impulse should be expected to boost growth, not interest rates or prices.

But this sort of dynamic exists only in weak economies, when the desire and need to save outpaces that of investment or spending. Conversely, in strong economies, at full employment on the graph, interest rates and inflation become a lot more responsive to more spending. That’s the FE’s case, in a nutshell. They think we’ve moved from the flat part to the up-slope.

[An interesting aside: the trade deficit is looking like it be an increasing drag on growth in coming quarters, slowing the rightward progress of that IS curve. If so, the extra government spending could offset the drag from trade, as it has often done in recent decades.]

At some point, I’d guess over the next 6-12 months, we should get a sense of who’s right. And “we” includes the Fed, who will likely move from brake-tap to brake-slam if inflation takes off. If, on the other hand, we see 1960s levels of unemployment pulling side-liners into the job market, faster wage growth throughout the pay scale, and some, but not too much, faster price growth (remember, given the Fed’s years of downside misses on their 2% inflation target, there’s ample room for some upside quarters; patience, Powell and Co.!), then team NYFE will look good.

There’s the political economy of all this, which I just don’t have the stomach to get into right now. I’ve been pushing for a version of this sort of fiscal policy–one with much better targeting, of course–for a long time, and while I certainly never envisioned it at 4% unemployment, here it is. I owe readers thoughts about the politics of all that and will eventually deliver. But for now, let’s stew on the econ.