Good Observations on Fiscal Policy

Karl Smith writes (sorry for quoting half the post):

Sometimes the net return-to-action is positive over the entire relevant range. In those cases smart finely tuned action is worthless and getting the most bang for your buck is actively harmful.

You always maximize simply by going full throttle regardless of the cost. This is because marginal benefit always exceeds marginal cost over your range. Note that this will generally not be the point that maximizes the rate-of-return or “bang for the buck.”

Thus, getting the most bang-for-your-buck is the wrong answer.

This is the perfect realm for something like fiscal policy. Efficiency is not something that central governments are good at. On the other hand, really-freaking-huge, is something that central governments are good at it.

A depression, where idle resources are plentiful and real borrowing costs are zero or negative is exactly where you find almost no return to precision.

Indeed, Austrians might find comfort in my suggestion that a general crisis is almost by definition a time when “knowledge of the particular circumstances of time and place” has low value. This is both why strong governments can do a lot of good in crisis and why people are wrong to assert that “if government is so good at mobilizing for war, then surely it can manage making shoes during a time of peace.”

That gets things exactly backwards.

To boil down his premise as I see it, efficiency matters increasingly less the farther the economy gets from potential, as there are few, if any, individual actions that will return the economy to potential.  I think this is a good simplification, but has some hints at oversimplification.  If one thinks of recoveries as a chain of related or semi-related events and believes that there are many chains that can be used to achieve recovery, then targeting the shortest chain should be the goal.  That may mean grasping at the first link in several chains to account for uncertainty (the public sector is not limited to one policy approach after all), but a slightly more targeted approach might be beneficial in selecting the proper chain of events.  Of course I am oversimplifying the process of determining the shortest course of action to a recovery, but this is a blog.

Economic Policies in 2012

The Economist‘s Money Talks this week looks at economic policy in the election.

President Obama’s Five Economic Goals

Evan Soltas is a really smart Princeton Undergrad blogger.  He argues on Bloomberg that the President has five very clear economic items on the agenda for a potential second term.  He writes:

Asking voters to “rally around a set of goals” for the country, Obama set several economic objectives — increasing exports, clean energy production and manufacturing employment — and others that were political, such as reducing the deficit and bolstering national security and education.

I’m not sure that I buy what he’s selling here, as far as a clearly defined economic agenda is concerned, but the article is worth the read and is a good introduction to Soltas if he’s new to you (this is actually our first time linking him here despite his relative prominence… my bad.).

The Original Housing Boom

Matthew Chambers, Carlos Garriga and Don Schlagenhauf have a new working paper at the St. Louis Fed that attempts to explain the growth in homeownership following World War II.  The paper concludes:

Government intervention via the mortgage market was a key part of the housing boom. The model suggests that moving from a 20-year to a 30-year FRM accounts for roughly 25 percent of the increase in homeownership. When combined with a narrowing mortgage interest rate wedge, the total impact of mortgage innovation is approximately 30 percent. Government intervention via tax policy was also a signiÖcant factor in the housing boom. The model suggests that the mortgage deduction can account for 13 percent of the increase in ownership. The model also Önds that the lack of taxation of housing services has an important e§ect on ownership.

Minimum Wage as a Conservative Position

Adam Ozimek writes:

But how do you design a policy that monitors low wage workers to ensure they are actually working harder? And how do you decide what the most productive ways for them to work harder are? Liberals may be comfortable designing some technocratic system, but conservatives would rightly be skeptical of this.  Instead, in an ideal system would be decentralized, with decisions made by those who know the least-cost ways to increase productivity.

It is my contention that this is exactly what the minimum wage does.

Two Safety Net Views

Adam Ozimek has written some interesting posts lately.  Last week he wrote about two concepts of the safety net.  He describes them as:

The first is to view the safety net as “mere transfers” that compensate the losers a dynamic economy produces…  However, many will also argue that because we have a safety net, a dynamic economy leads to fiscal costs.

 

Will Wilkinson on Obama Math

Sorry for the lack of posts this week (I’m on vacation in Chicago). While sitting in Midway airport I just read an interesting post by Will Wilkinson at Democracy in America. He concludes:

Perhaps reducing income inequality would by itself improve the quality of our democratic institutions or reduce the risk of a socially destabilising sense of exploitation and stratification. Perhaps. But Mr Obama’s notion that the rich get more out of our common institutions than they put in is questionable, to say the least. And his suggestion that opposition to higher top income-tax rates could only be based on by-the-bootstraps social atomism is a silly bit of bad faith.

The entire post is worth reading for its honest assessment of success and Mr. Obama’s arguments about taxation. Unlike some of the commenters, I think Wilkinson, while critiquing the President’s statement, makes a clear break with hyper-capitalist ideology that would say success is the sole product of an individual.

Centralized Government, Taxation and Growth

Marginal Revolution guest blogger Mark Koyama looks at the history of centralization of government, subsequent taxation and growth thereafter of European economes.  He notes:

The implication of this argument is that an increase in the measured size of central government need not have been associated with an increase in the total burden of government. Rather the total deadweight loss of all regulations and taxes could have gone down in the 18^th and 19^th centuries, even as the tax rates  imposed by the central state went up.

Koyama provides the figure below as some evidence.

Impact of QE

Need to see the impact on long term real treasury yields of quantitative easing?

Taxes and Cheap Public Borrowing

Matt Yglesias writes in defense of a suggestion to temporarily end income taxation:

Normally you face a tradeoff. Taxes impose costs on the present-day population that might impair wealth creation over the long-term, but to avoid taxes by borrowing you need to pay interest to creditors. But the real interest rate we’re being asked for is low. Less than zero. So what’s the tradeoff? Why not sell as many negative-yield ten-year bonds as the market will buy (sell enough bonds and presumably interest rates will rise) and let that auction revenue “crowd out” taxes as a way of financing government activities? Now in an ideal world we’d use that money to finance valuable public sector investments, but that all gets very politically controversial and you can see why it’s impossible to agree on this given our dysfunctional politics. But what’s the constituency for taxes in a negative interest rate environment?

Tyler Cowen unintentionally responded to this Matt, saying, “Maybe, but keep in mind that the interest rates on quality government debt are down, in part, because the risk premium is up.”

I tend to fall with Cowen on this.  Because something is a relatively unrisky asset, it is not necessarily an unrisky asset.  It might be advisable on some level to take advantage of cheap public funds right now to stimulate growth, which presumably would grow the economy and reduce the risk premium by improving the state of the private sector.  This is all assuming that public issues are inversely correlated to the private economies performance in some way (increasing public debt will not impact private sector confidence), but the chart below from yesterday’s Stevenson-Wolfers article that I linked seems to suggest otherwise.