Monday, August 22, 2011

Economic Policy: Treating Symptoms, Treating Causes?

Mike Smitka
...Inaction is the Best Medicine?...
The question: can we use an analogy from medicine, that we should treat the disease rather than the symptoms?
  1. Of course treating the common cold or a mild case of the flu may not be worth the effort (tamiflu?!) -- take 2 aspirin, drink lots of fluids and go to bed.
  2. Where there is no direct treatment, or the symptoms themselves are dangerous (and the diagnosis pending) then treating symptoms may be the best policy. That's the standard plot on House, someone's dying, treat the symptoms while the detective work progresses. Of course, to fill up the hour the first choice backfires (or works but then new problems crop up).
  3. Sometimes though the effects of the disease don't, or won't ever, reverse themselves. The stroke is over, blood is flowing but...or the rheumatic fever has subsided, but the heart valve is shot and won't heal itself. Treat the aftereffects, not the cause.
  4. The patient may not cooperate. In the (really) old days of cable bindings skiers broke bones with alacrity. You could set the bone and mostly get it to heal. But keep on skiing ... well, you haven't treated the disease and next time it may be a joint that can't be fixed. I suppose a better example is obesity: few doctors will tell someone "get lost until you lose weight." Now it's good for business, and many patients may be too addicted to snacking and watching TV to shift their net caloric intake (fighting alcoholism may be easier, after all our bodies can survive without drinking, but you can't stop eating). In economic terms, political economic calculations may mean you know what you ought to do, but don't.
So in fact when I think more deeply about the medicine analogy, it suggests there is no quick answer for what an economist ought to propose.
I still hold that best practice remains diagnostic-based treatment. But let me return to the list above.
  1. Being reticent to act is not a bad thing. There are always "shocks" to an economy, good and bad, but in developed countries our economies are both very big and resilient. The effect of most shocks is transient, even when the impact can with hindsight be discerned in the data. Policy has side effects, it can be hard to change and hard to reverse if it creates "winners" (an example is the capital gains tax exemption in the US, originally put in as a response to the distortions caused by the late 1970s inflation). In the macroeconomic context, textbook models suggest that adroit fiscal and monetary policy can eliminate the business cycle, but getting the timing right is hard because the "normal" cycle is short (reverses itself) and we tend to use the wrong policy tools (monetary policy to slow an economy, fiscal policy to boost -- the opposite is ideal). So we have both side effects (higher real interest rates coming and going) and may be giving the wrong medicine (no need to push down body temperature once the fever's gone).
    The losses from Japan's earthquake were horrific and even if we can rebuild, we reverse death or undo privation. But from the perspective of the economy as a whole it was still a fairly small event, and even if Toyota and Honda lost a lot of production, rivals were less affected. So the underlying competitiveness and complexity of a modern economy means there are lots of substitutes. So while there was a short-term impact there's no reason that macroeconomic policy need change. (But every reason to devote resources to the local "microeconomic" level.)
    Back to the practical problems of real-time policymaking. This was Milton Friedman's bete noire -- after all he used the same Keynesian analytic framework, so it was not theory that drove him but pessimism about policy makers and the policymaking environment. He wanted a world of rules. Unfortunately the world proved too complex for simple rules, which he himself recognized in his latter years. As long as we permitted innovation in financial services, rules would need to evolve. Ideological correctness is insufficient: with irony, it was Greenspan the conservative/libertarian who poured fuel on the flames of a financial system fixated on short-term returns while trading long-term instruments. Financial innovation provided insurance policies, yes, but not as fast as financial innovation multiplied risk.
  2. Does the economy always quickly recover? Clearly, no. We should be chary of panicking at every sign of recession or the cry of inflation that comes every commodity spike (we are wont to confuse shifts in relative prices from aggregate inflation when it comes to the prices of gasoline and veggies.) That's point #1.
    But neither should we bury our heads in the sand and say things will pass when all evidence speaks to the contrary, when unemployment or inflation is suddenly a multiple of desirable and presumably feasible levels.
    So when the patient may be dying, provide stimulus. If that doesn't work, provide more. It's not hard to back off of emergency measures -- the Civilian Conservation Corps was folded pretty quickly. [President Eisenhower found it harder to trim the War Department, by then artfully renamed the Department of Defense, but its growth was never premised upon macroeconomic necessity, even though commentators from at least the 19th century had pointed out that wars on other people's land weren't so bad, particularly when in the post-draft era they are from a policymaker's perspective fought by other people's children.]
    Keynes in fact was a good example. On matters economic he was a conservative, but he had warned about the large macroeconomic flows built into Treaty of Versailles reparations as something that would be beyond the bounds of normal macroeconomic adjustment. Then, in the 1930s, he found himself staring at 20% unemployment in Great Britain, well, it was clearly not a run-of-the-mill downturn. Worse, he was looking into the abyss of socialism -- in Germany, the National Socialist Party of Adolf Hitler, and there was populism and radicalism at home.  Something was sorely amiss, and sitting on his hands wasn't an option, even if as the creator of modern macroeconomics he was at times groping and unsure of his way (or more precisely, incoherent.) Keynes didn't view his task as that of a plumber fixing the odd leak along a dike; he saw a dike about to collapse with raging floodwaters set to inundate hist beloved England.
  3. Macroeconomic damage is fundamentally irreversable. If you've lost your job and can't find one for 9 months, it becomes increasingly difficult in many industries to get hired back to a similar position. You can never make up for lost consumption -- the pain of telling kids "no" can't be undone. When it lasts long enough, small businesses fail and teachers get fired and roads don't get maintained and communities lose coherence. If you've lost your house, it can take a while to rebuild your credit rating, not to mention build up the downpayment on another house. And if in the interim you've been unable to afford healthcare and haven't been able to pay college tuition, there's long-term damage. These affect society as a whole, too, and not just those hit directly by economic trauma. So while we may not be sure what's causing unemployment, we certainly can engage in direct job creation or pay extended unemployment benefits and offer subsidies to state and local school systems and hospitals to mitigate the side effects of recession.
  4. A financial system that collects fees up front for selling assets that are long-lived has a built-in conflict of interest. Straight bank loans to small businesses are less problematic, because they tend to have a shorter maturity (lessening the mismatch between the time horizon of a bank's assets and liabilities) and because banks can't sell such loans to others as readily and so are more careful in their decision-making. (Asides: the 90-day line-of-credit is illusory, since most businesses structure themselves as ongoing entities; maturity mismatch remains. Likewise the bankers who originally made the loans may well have moved on, and not suffer the consequences of bad decisions.)
    But straight banking is now a small fraction of our financial system. The securities industry, which is what banks have morphed into, is huge, and with a regulatory system that emphasizes the letter of the (common) law, we seem unable to restrain the growth of "shadow banks". When money is "tight" shadow banks and securities firms have a harder time raising funds, and the yield curve can work against them. But it's like a case of AIDS, with a combination of basic regulation and normal monetary policy we can restrain its ability to cause illness but to date we can't eliminate HIV entirely. Lapses in medication lead to bad outcomes.
So perhaps medical analogies have their use. There is however no (simple?) diagnose-and-treat lesson to be had. Rather, it is that the economy, like the human body, is very complicated, and textbooks will only get you so far. Medicine remains rooted in apprenticeship. Economics must as well

Tuesday, August 16, 2011

Perry and Treason

Mike Smitka
...(your) Unemployment is Good! (for me)...
Treason is a serious charge; I would hope that a presidential candidate would not bandy it about lightly.
But first, I find it unsettling that Rick Perry seems to have flunked Economics 101 in his diatribe yesterday against the Fed, that it should not "print money." He fails to understand that in our (and every other) modern economy banks create money, not the government. That was true when the US was on the Gold Standard, too. The Federal government does print paper bills – but it is Treasury that oversees the Comptroller of the Currency; the Fed has nothing to do with it. Is it too much to ask that someone wanting to be chief executive know a little bit about the tools of governance, or at least listen to people who do?
Second, Perry exhibits a lack of intellectual principles. He charges the Fed with treasonous behavior. He seems to be unaware of Milton Friedman's 1963 magnus opus with Anna Schwartz, A Monetary History of the United States, 1867-1960. Whatever flag of conservatism Perry might be claiming to wrap himself in, it's not Friedman's. Friedman and Schwartz do deride the Fed, justly, for turning the 1929 market crash into a depression – but for not printing enough money, not for printing too much![Note 1] So Perry wants not only to repeat the budgetary idiocy of Herbert Hoover, he wants to repeat the monetary idiocy of Roy Young and Eugene Meyer, the successive Chairmen of the Board of Governors of the Federal Reserve System during 1927-1933. So Perry makes it clear that he has no conservative principles, only campaign ones.[Note 2]
This campaign focus extends to moral principles; Perry displays an ethic that is, well, so self-centered that I find it hard to fathom: he wants the Fed not to print money because it might create jobs and lessen his election prospects. Yes, for his own vanity he wants to keep millions of Americans unemployed.
I'm resigned to the occasional bad student; academic firepower isn't all that matters. Diligence does; even my bad students do their homework, and learn to stick to a consistent line of argumentation. But to lack principles -- well, at Washington and Lee Honor Code violations get you expelled, though guilty verdicts in practice are hard to come by.
I hope primary participants quickly expel Perry from the race. As President he would take an oath to uphold the Constitution, the opening sentence of which states that one purpose of the Federal government is " promote the general Welfare...." He must believe that once someone is unemployed they are no longer worthy of being considered a citizen. But that's not what the Constitution says: even slaves counted (though not for much).
Perry is apparently quite willing to destroy livelihoods for his own political benefit. But I don't bandy around the charge of treason lightly; however reprehensible I find that stance, I don't think it merits accusing him of seeking to destroy the country.
Note 1: Ben Bernanke lauds their work; I do as well, though I am uncomfortable with the monocausal view of the causation of A Monetary History. The link to Wikipedia provides a start for those who want to know more of the details.
Note 2: Obama is little better in practice: his stated goals are not pernicious, he on occasion talks a good talk on policy. But refuses to walk the walk, neither leading nor following through. Perhaps he too cares only about his standing in the polls.

Monday, August 8, 2011

Bugger Gold

Mike Smitka
...Gold is for Fools...
The case for commodity metals as an investment must rest either on a supply/demand story or on expectations. Now platinum is valuable as a chemical catalyst. However, dear to an economist's heart, when prices rose for legitimate scarcity reasons, then lo and behold! -- there are other catalysts out there. Gold has some industrial uses, due to its chemical inertness and electrical conductivity. But not many, at current prices. Then there is jewelry. OK, the world's middle class population is growing, though "bling" tends to fads. However, inventories are huge relative to that demand. So gold's value rests fundamentally upon speculation.
Worse, that speculation is driven by one story: inflation. As a Japan specialist, I'm more familiar with the opposite: Japan has seen consumer price deflation, admittedly at low levels, for a baker's dozen of years, while the domestic corporate goods index has fallen on an episodic basis for 25 years. Yet this is despite an increase in base money that in the old days economists of all stripes would have presumed a harbinger of hyperinflation.
Well, the US and EU are set to follow Japan's path. Underlying a rise in prices must be an increase in the largest single cost in a modern economy, labor. I don't see that happening anytime soon. Institutional rigidities make downward wage adjustment slow -- compensation systems in large employers in Japan are highly bureaucratic. But such employment didn't expand; contingent employment did. Japan is now a nation of part-time and short-term contract workers, at least among the young and women and older workers. Worse (better? -- consider the alternative!), productivity also rose. Paired, they meant falling costs.
Institutions in the US and the EU differ; our bias is towards unemployment rather than falling wages. But all in all I'm betting on mild deflation -- and hence I'm not buying gold.[note] There's a flood coming, and the foundation of today's prices is muddy, not even sand. Gold prices should be falling since 2008, not rising.
In Edgar Allen Poe's whimsical short story "The Gold Bug" there is method in madness. In today's markets there is only madness.
Note: To be honest, I'm the unintended owner of two houses, so I've no leeway to buy anything!

Friday, August 5, 2011

Who Feeds Leviathan? -- Children!

Mike Smitka
...Leviathan is the creation of 10-year-olds...
What of Leviathan? Let's rely upon data, here the Bureau of Labor Statistics Employment Situation Table B-1. [note]
First, where are all those bureaucrats I hear about in the local coffee shop? Their level peaked in 1991, a consequence of the policies of the Reagan era. Yet in the following decade our population, our national income and the complexity of our economy increased. We're trying to provide basic government services on the cheap. Now Social Security checks no longer require an army of paper pushers to get them out each month. But checking for food stamp, tax and medicare fraud -- that requires more, and more skilled workers, not fewer. Don't moan to me about welfare cheats in the same breath you complain about the size of government!
So who created Leviathan? – children did! The only significant source of government employment is education. As our population rose, so did the number of teachers.  Despite continued population, increases, however, their numbers were down by 250,000 going into the summer; given budget pressures, it's anyone's guess how many additional cuts will become visible as school starts. But those I hear railing against Big Government in the local coffee shop are retired or approaching retirement; they have no stake in what happens 10 years from now, when today's kids hit the job market. In contrast, tax cuts are immediate...
Note: BLS data don't include those on active military duty, an artifact of the days when military service was involuntary.

Wednesday, August 3, 2011

Tea Party and Tea Tax

The Tea Party makes liberal reference to the "founding fathers" as the bedrock, the principals upon which their principles rest. So what of taxes on tea?
For the answer I checked that old stalwart, Davis Dewey, Financial History of the United States, New York: Longmans, Green, 1902. 1791-1901, which apparently was "the" text for public finance in the early part of the last century, as there was a new edition every few years through at least 1920. See pp. 80-82 for details.
Given the exigencies of the time, a tax bill was submitted to Congress even before George Washington was inaugurated; the bill passed on July 4, 1789. So what did they tax? -- tea! And not modestly, but at a rate of 6¢ to 20¢ per pound. Furthermore, if the tea was carried on a foreign vessel, then that rate was doubled. By the 1870s -- that particular tariff was abolished in 1872 -- it was raising roughly $10 million per year, a tidy sum for that day and age.
For the Founding Fathers, tea was an important symbol (and practical target) for the need for revenue to support the functions of government that underlay the shift from the Articles of Confederation to our current constitution. The fight hadn't been against taxes, the challenge wasn't limiting government, it was finding sources of revenue to support the expansion of government to provide the services that the British would not. Patriots gave their lives for a government that would serve the people, for the right to levy taxes, if need be (and the need was there) for higher taxes.
Mike Smitka, August 3, 2011