The Unseen Costs of Easy Money

For several years now the Federal Reserve has been printing money (quantitative easing) and lowering interests (through the discount window) in attempt to improve the US economy . Here's why that's not that great of a great idea:

More than any other policy action, monetary policy suffers from the sense that there is a free lunch to be had. Yet the interest rate is a price for the savings that are transferred to spenders. To the extent that the Fed manages to push this price down (and some economists will dispute its ability to push any meaningful interest rate down), it taxes the producers of savings and subsidizes the spenders of savings. Clearly, no government considers pushing down the price of any real good an effective way to stimulate the economy – any gain to consumers is a loss to producers, and the loss typically will outweigh the gain if the market price is a fair one.

Do we really want to be discouraging saving and encouraging debt?

The Stimulus Package Didn't Work

I've have discussed the stimulus package a lot. Here's the closing data:

Our benchmark point estimates suggest the Act created/saved 450 thousand government-
sector jobs and destroyed/forestalled one million private sector jobs. The large majority of
destroyed/forestalled jobs are in a subset of the private service sector comprised of health,
(private) education, professional and business services, which we term HELP services.

Politics of the Stimulus Package

There are few issues I've given more blog time than the stimulus package, but I think a trillion dollars is worth my time. And yes, this is the fifth part of my series against self-verification, but no, I'm not a Keynesian now. It's not that I've been wrong about the stimulus, I've just been wrong in my discussion. My main argument has been that we can't know if it works, so why try. Economist Alex Tabarrok gives a much more rigorous argument. Even the most ardent stimulus package supporters agree that the recent package did not stimulate the economy becasue it wasn't big enough. It is very difficult for democratic governments to get the political support required to spend the money supposedly needed to stimulate the economy. Even in the Great Depression, where FDR spent more than 120% of GDP, Paul Krugman admits that wasn't enough. So here's Alex's argument:

Now I will take a large degree of laissez-faire and the chaos of democracy over authoritarian political and economic regimes any day. I assume most Keynesians would as well. Thus, if we can't count on massive increases in government spending during a recession to mop up problems ex-post shouldn't we all, Keynesians and otherwise, be spending more time thinking about ex-ante alternatives to Keynesian politics?

And here are his solutions:

Greater regulation to prevent crises from occurring is a legitimate response, although one that I wouldn't necessarily buy into in all particulars. Along the same lines, increasing wage, price and real flexibilities (e.g. relocation flexibility and public and private savings flexibility) would benefit us in future recessions. Automatic stabilizers such as unemployment insurance are one area that has worked quite well. What other areas can be automatized? Funding for states? How about an automatic payroll tax cut tied to the unemployment rate? (fyi, Keynes favored the latter).

Even if the economics of Keynesianism works, the politics of it doesn't.

Yet Another Look at Government Stimulus

I know I've belabored this issue to death, but with the costs so large I think it's worth at least one more look. Over two and a half years ago I first predicted that the stimulus packages would not work. Later I posted that the stimuluses probably didn't work in the past (especially the New Deal) and that at best we'll never know if the cost was worth it. I eventually concluded that stimulus as a temporal tax progressive tax is the best and least used argument in favor.

The most famous example of government stimulus is World War II. And it with Ben Bernanke's recent announcement to print an extra $600 billion in a process called quantitative easing (aka increase the money supply), it seems the Federal Reserve's faith in government stimulus has not waned. However, a recent paper published by David Henderson suggest that World War II is a great study on stimulus, except that it proves the opposite of what you might think. First, here's the traditional thought process:

We often hear that big cuts in government spending over a short time are a bad idea. The case against big cuts, typically made by Keynesian economists, is twofold. First, large cuts in government spending, with no offsetting tax cuts, would lead to a large drop in aggregate demand for goods and services, thus causing a recession or even a depression. Second, with a major shift in demand (fewer government goods and services and more private ones), the economy will experience a wrenching readjustment, during which people will be unemployed and the economy will slow.

Now's here's the reality:

Yet, this scenario has already occurred in the United States, and the result was an astonishing boom. In the four years from peak World War II spending in 1944 to 1948, the U.S. government cut spending by $72 billion—a 75-percent reduction. It brought federal spending down from a peak of 44 percent of gross national product (GNP) in 1944 to only 8.9 percent in 1948, a drop of over 35 percentage points of GNP.

While government spending fell like a stone, federal tax revenues fell only a little, from a peak of $44.4 billion in 1945 to $39.7 billion in 1947 and $41.4 billion in 1948. In other words, from peak to trough, tax revenues fell by only $4.7 billion, or 10.6 percent. Yet, the economy boomed. The unemployment rate, which was artificially low at the end of the war because many millions of workers had been drafted into the U.S. armed services, did increase. But during the years from 1945 to 1948, it reached its peak at only 3.9 percent in 1946, and, for the months from September 1945 to December 1948, the average unemployment rate was only 3.5 percent.

Selfish Reasons for Immigration

This may have replaced drug legalization as my issue of most interest. You've heard the moral, historic, and economic reasons for and the honest concerns against increasing US immigration. Now here are some selfish reasons for it:

Immigrants will solve our housing crisis. One major reason why housing prices remain in the doldrums and sales remain slack is that there are simply too many houses for sale. The National Association of Realtors reported that in July, there were 3.98 million existing homes on the market, representing a 12.5-month supply at the current pace of sales.

Here's another:

Immigrants are needed to replenish the American workforce. While the American labor force continues to grow, the rate at which it grows has been slowing down for decades. The Bureau of Labor Services projects that by 2020, the growth rate will be just 0.4 percent per year, and by 2030 just 0.3 percent per year. Some of this is attributable to baby boomers moving into retirement homes, and some is attributable to declining birth rates.

And one more:

Immigrants make the economy better. Not only does the San Francisco Fed paper—written, appropriately, by an Italian economist, Giovanni Peri—argue that immigrants don't hurt the economy, it actually makes the case that immigrants are putting money in the pockets of native-born workers. Specifically, it says that "total immigration to the United States from 1990 to 2007 was associated with a 6.6 percent to 9.9 percent increase in real income per worker."

All of those talking about the need for a second stimulus should take my intro economics class. The best way to increase demand is to increase the number of demanders.

Related: In France at least, an increase in immigrants does not mean an increase in crime.

Lessons from the German Economic Miracle

In a recent comment a reader proposed that the post-WWII Marshall Plan was a great example of government stimulus leading to national prosperity. Based on my previous posts on foreign aid, you might guess I don't agree with the common assumption. Economist David Henderson also disagrees and claims economic growth was mostly due to three other factors:

The two main factors were currency reform and the elimination of price controls, both of which happened over a period of weeks in 1948. A further factor was the reduction of marginal tax rates later in 1948 and in 1949.

The article goes into a lot more detail, but here's his specific response to the Marshall Plan story:

Marshall Plan aid to West Germany was not that large. Cumulative aid from the Marshall Plan and other aid programs totaled only $2 billion through October 1954. Even in 1948 and 1949, when aid was at its peak, Marshall Plan aid was less than 5 percent of German national income. Other countries that received substantial Marshall Plan aid exhibited lower growth than Germany.

The Economic Stimulus Package, Last Part

Two years ago I posted on why I didn't think the stimulus package would work, why I didn't think the very very first worked, and why I might consider it as a "temporal progressive tax". But since the Federal Reserve recently predicted the recovery is slowing down, it's worth one last look. In this NPR podcast (via Justin) one of my favorite economists Tyler Cowen puts it like this: there has never been a very good test of Keynesian stimulus and in fact, this last stimulus package has probably the best chance to test it. A year and half ago he predicted it wouldn't help, and that it wasn't worth the risk to spend a trillion dollars on an untested idea.

But here's the worst part, because the macro-economy is so large and so unwieldy, even though this stimulus hasn't ended the recession in the predicted amount of time, it proves nothing. Supporters can reasonably say it would have been worse without it. Although I can't say with completely certainty the stimulus package has done more harm than good, the opposite can't be proven either. And it seems the burden of proof should be on the party wanting to spend a billion dollars.