The Treasury View

Eugene Fama, a very distinguished finance specialist at Chicago, has been arguing that government spending cannot stimulate output as a matter of logical necessity (see the subsection of his article "The Sad Logic of a Fiscal Stimulus")

Like the auto bailout, government infrastructure investments must be financed -- more government debt. The new government debt absorbs private and corporate savings, which means private investment goes down by the same amount [...]Stimulus" spending must be financed, which means it displaces other current uses of the same funds, and so does not help the economy today.

John Cochrane, also of Chicago, has arguably made a similar point here.
Certainly he is sceptical about traditional fiscal stimulus:

The central question is whether fiscal stimulus can do anything to raise the
level of output. The question is not whether the “multiplier” exceeds one –
whether deficit spending raises output by more than the value of that spending.
The baseline question is whether the multiplier exceeds zero.

These arguments esentially repeat what was known as the Treasury View during the Great Depression. With the help of Keynes and others, this was shown to be a fallacy. What people like Paul Krugman and Brad DeLong are scratching their heads about, is how can this fallacy still exist as a serious argument?


It is worth reading Krugman's response, as it nicely describes why this argument makes the mistake of interpreting an accounting identity as a behavioural relationship, or equally Brad DeLong discusses the Treasury View here, and gives an example to explain the fallacy here (although this may be hard to follow).

Bang for the buck on public spending

There is a big debate amongst economists at the moment about the need for and effectiveness of a fiscal stimulus package (see Jonathan's post about Barro vs Krugman).
This article by Paul Krugman about dynamic scoring and the "bang for the buck" on public spending in the US basically asks: how should we measure the cost of effective fiscal stimulus?

Bang for the buck on public spending

There is a large debate amongst economists at the moment about the need for and effectiveness of a fiscal stimulus package (see Jonathan's post about Barro vs Krugman).
This article by Paul Krugman about dynamic scoring and the "bang for the buck" on public spending in the US basically asks: how should we measure the cost of effective fiscal stimulus?

Large transfers from taxpayers to bankers

On bonuses in the US financial sector last year despite the crisis:

«Despite crippling losses, multibillion-dollar bailouts and the passing of some of the most prominent names in the business, employees at financial companies in New York, the now-diminished world capital of capital, collected an estimated $18.4 billion in bonuses for the year.

That was the sixth-largest haul on record, according to a report released Wednesday by the New York State comptroller.(...)

Lucian A. Bebchuk, a professor at Harvard Law School and expert on executive compensation, called the 2008 bonus figure “disconcerting.” Bonuses, he said, are meant to reward good performance and retain employees. But Wall Street disbursed billions despite staggering losses and a shrinking job market.

“This was neither the sixth-best year in terms of aggregate profits, nor was it the sixth-most-difficult year in terms of retaining employees,” Professor Bebchuk said.

Echoing Mr. DiNapoli, Professor Bebchuk said he was concerned that banks might be using taxpayer money to subsidize bonuses or dividends to stockholders. “What the government has been trying to do is shore up capital, and any diversion of capital out of banks, whether in the form of dividends or large payments to employees, really undermines what we are trying to do,” he said.(...)

Andrew M. Cuomo, the New York attorney general, has issued subpoenas to John A. Thain, Merrill’s former chief executive, and to an executive at Bank of America, which recently acquired Merrill, asking for information about Merrill’s decision to pay $4 billion to $5 billion in bonuses despite new, gaping losses that forced Bank of America to seek a second financial lifeline from Washington.(...)»

Read the full article here. For an old but very interesting article about the evolution of CEO compensation, read this.

A costly coordination failure...

No comment.

Krugman vs.Barro

Here are links for the items discussed in today's lecture. Robert Barro's piece "Government Spending Is No Free Lunch/Now the Democrats are peddling voodoo economics" in a recent Wall Street Journal arguing that the multiplier is less than one is here. Krugman's response and update (with the figure for house building and expenditure on cars before, during and after the war), basically makes the point that there was a war on. A fall in some types of expenditure is not totally surprising!

Terminology: convex indifference curves

From an article by A. Kozlik in the American Economic Review, Mar 1941.

I was asked about the expression used in one of the first year problems sheets, "convex to the origin", when asked to describe the usual way economists draw indifference curves (i.e., when they satisfy a diminishing marginal rate of substitution- = get flatter -as you move to the right). Clearly our terminology has been inconsistent for a long time. The textbook uses the expression "bowed to the origin". The above article argues that (c) is the best solution, but I am not sure his recommendations were ever taken seriously.

Economic experiments

Yesterday took place the last session in the series of economic experiments that we have been running during the last few days. In terms of organisation and participation, the experiments were a success. A total of 77 students took part in them, very close to our target, many of them from Economics 1A. We would like to thank all students who took part for their interest, curiosity and ethusiasm. These experiments were part of one of our research projects aimed at studying how real people make decisions. The readers of this blog will be the first ones to be informed about the results once we process them in the form of an article. Meanwhile, thank you so much for your participation!

Who said you needed textbooks?

Interview with the head of Zimbabwe's reserve bank, aka "Mr. Inflation":
«Your critics blame your monetary policies for Zimbabwe's economic problems.
I've been condemned by traditional economists who said that printing money is responsible for inflation. Out of the necessity to exist, to ensure my people survive, I had to find myself printing money. I found myself doing extraordinary things that aren't in the textbooks. Then the IMF asked the U.S. to please print money. I began to see the whole world now in a mode of practicing what they have been saying I should not. I decided that God had been on my side and had come to vindicate me.»
More on the Newsweek website.

Recession

(Graphic from FT.com.) As of last week, it's official. We are in a recession (which everyone knew anyway). Officially you need two quarters (quarter = 3 months) of negative GDP growth, and since three quarters ago growth was precisely zero, that didn't count.  Martin Weale, director of the National Institute for Economic and Social Research, said that, based on its estimates, the recession began in May 2008 and the economy had contracted 2.7 per cent from its April peak. The FT has an interactive graphic which shows output growth in a range of countries over the last 100 years or so.

A Question for Class Discussion

This is from Greg Mankiw's blog.

The NY Times reports that the new president is concerned about how banks are using TARP funds [JT: TARP=The Troubled Asset Relief Program , a US government program to purchase assets and equity from financial institutions to help improve the situation of the financial sector]
[President Obama] criticized companies that have used federal money they received under the financial bailout for low priority or wasteful purposes and promised not to let that happen. He cited “reports that we’ve seen over the last couple of days about companies that have received taxpayer assistance, then going out and renovating bathrooms or offices, or in other ways not managing those dollars appropriately.”

A prominent economist emails me the following:

Discussion question.
Scenario 1. AmeriBank of Holland, Ohio, receives TARP funds and uses $20,000 to hire Joe the Plumber to remodel a bathroom in one of its banks.
Scenario 2. AmeriBank of Holland, Ohio, receives TARP funds and loans $20,000 to Bob the Baker to remodel a bathroom in his house.
Explain the difference in macroeconomic stimulus in these two scenarios.

Anyone want to venture an answer? (Just enter a comment below)

The way to a woman's heart

This is a link to the study I spoke about in my tutorial which suggested that the way to a woman's heart is to give her a bad gift.

Are economists hot? Apparently not.

This is from the Crooked Timber website, and is based on data from RateMyProfessors. Apparently even the highest scoring subject (languages) gets a negative score, which is a bit depressing...

At least we beat the accountants.

(Click to enlarge picture.)

How bad is the recession going to be?.

This shows the current recession in the US (employment decline since peak) relative to other post-war recessions. The calculation of when a recession starts is done by committee in the US (whereas in the UK it is simply two successive quarters of negative output growth). It was computed by Alex Tabarrok. (Click for larger picture.)
Some economists think things are going to turn around quickly. This is from Nicholas Bloom and Max Floetotto at Stanford. (Click for larger picture.)

What economists research

This is a picture made by Paul Kedrosky from the titles of all 505 papers at January's American Economic Association meetings, using a programme called Wordle. The more a word appears in a title, the larger it will appear in the picture.

Welcome

Welcome to the UoEdinburgh Economics blog! Contributors will be members of the economics department (incl. tutors).  Hopefully it will contain material of general interest to your course, although not guaranteed to always be about economics (or of interest). Also from time to time it might contain material from particular lectures/tutorials. Given the current situation, I anticipate that macroeconomic issues will fill quite a lot of the posts. Suggestions or questions are always welcome.

Jonathan Thomas

cont.

Act 2 then is a story of economic slowdown and recession. Businesses found - and are finding - it hard to get access to finance; house buyers found - and are finding - it difficult, sometimes impossible, to get a mortgage; gradually real economic activity began to slow, and when that happened the deceleration got worse and share prices and house prices fell. When people feel poorer, they spend less, and when they spend less, they make other people poorer.

What has taken me by surprise is the speed of events. When I was first asked to talk to you, in November, the topic was the credit crunch. Barely 4 months later, we are talking now about a global depression similar to the 1930s. All advanced economies are affected, and many less advanced economies. Economies with large financial or banking sectors are badly affected: Iceland, the UK, Scotland.

The policy response in Britain and the US, and to a lesser extent in most European economies, has been twofold. Firstly to lower interest rates, supplemented more recently by direct intervention in the form of ‘quantitative easing’. Secondly, increases in government spending, i.e. fiscal stimulation on quite a massive scale. This itself may cause problems, as the future public finances look distinctly fragile. Some economists who have crunched the numbers have estimated that the UK public debt will not come down to its former levels for a generation; that debt has to be paid off at some point, and other spending ambitions will have to take sacrificed. All this may have the effect of making today’s consumer (who is tomorrow’s taxpayer) even more cautious about spending. There is therefore a vigorous debate amongst economists as to whether more government spending, and thus more government debt, is really the answer. After all, was not too much debt not the problem in the first place?

And this brings me to the big question: how well placed is the UK (and Scotland) to withstand this recession? And what could we have done about it?

Britain is a very open economy, heavily involved in international trade. We export a lot and we import a lot. By itself, that is a good thing. But we are then sensitive to developments abroad, and the slow down in foreign markets will hit us hard. Against that we can set a depreciation of sterling that is making our exports more competitive. But will more foreign tourists come to Edinburgh? It’s good value, but they are poorer.

The UK economy has many peculiarities; one is our obsession with home ownership. Almost uniquely in advanced economies, we are encouraged to get on the property ladder early, and for most this involves getting a mortgage. Until recently, it was quite easy to get a mortgage, as banks were willing to lend large sums, secured not against income but against future price increases. These in turn were assured by buoyant demand and an almost static supply, in part the result of restrictive planning regulations. Combined with the liberalisation of credit and financial markets, we have found it only too easy to borrow money.

But so has the government. When he first became Chancellor, Gordon Brown set down rules for the control of government debt. The Golden Rule was that, on average (i.e. over the economic cycle) the government would not borrow to finance current expenditure, only to finance investment in hospitals etc. But as the government spent more on the doctors, and education, and tax credits, and all these worthy things, it could only meet the Golden Rule by redefining the economic cycle. In effect, it extended the period over which the cycle occurred, giving it leeway to spend more now and repay later. But later never came, and by the time the crisis hit the UK, the public finance were already in poor repair. So just when we need a strong financial position, so that the government can spend to get the economy back on track, we find that we start from a position of high debt.

Of course, if the private sector (consumers and firms) and the government are both borrowing, that means one thing: a large current account deficit. And this is something no one worried about. But it was the symptom of an economy living beyond its means, and borrowing from abroad to finance expenditure in excess of income. When we do that for year after year, then when we really need to borrow, it is that much more difficult, and people start to question our ability to pay it back. This is one reason for the weakness of the pound; some commentators have speculated that the UK may need to borrow from institutions such as the IMF. That would be political death for any government: if Gordon Brown was forced to go to the IMF then that would probably be the end of the Labour Party. So he will do his utmost to avoid it, so expect tough decisions on government spending and taxes in the next budget on 22 April.

So, way are we in this mess? Because as a country, we like to consume too much; we are too prepared to borrow and spend now; our banking sector has been allowed to have a disproportionate influence on the economy, and the quality of banking and financial regulation has been execrable. The government has gradually let the public finances get out of control, has paid too much respect to bankers and financiers, and not asked hard questions of them. Nor have shareholders (including our pension funds). There have been profound failures of corporate governance: why have the non-executive directors of banks been so spineless in protecting shareholder interests? Is it really the case that, in their heart of hearts, the whole board of RBS agreed with Fred Goodwin and thought it a good idea to buy ABN-Amro? Why were they so feeble in resisting his grandiose idiocies? Their negligent behaviour is an interesting area of analysis not just for the economist but also, I would suggest, for the criminal lawyer.