Monday, August 16, 2010

Can't Say I'm Surprised: Interest Rates Fall Even Further

The NY Times has a decent overview of fears related to recent bad economic data. Now I don't think too much should be read into this, it's a short spike in bad data and who knows what next month will bring. This may prove to be just a blip.

That said, I think from the outset of the crisis things were handled badly, especially in the US. Somehow the "responsible" thing to do came to be framed as undershooting estimates because it was seen as more "responsible" to do too little in case things turned out not to be as bad as feared. If we did too much than we'd be left with huge debt either way, if we did too little than if things turned out well we'd have less debt. Didn't make sense to me from day one.

Of course, even given these screwy incentives things may not have turned out so bad; our stimulus program probably could have been fairly effective if targeted correctly, even if it was somewhat too small. The Republicans deserve a huge black eye for the poor targeting of stimulus, while the Democrats weren't exactly paragons of responsiblity it was the Republicans demanding that as much of the stimulus as possible consist of tax cuts, which everyone at the time was saying would be the least effective form of expenditure. They successfully framed the debate in a way that secured this objective even while largely voting against the plan, insuring they would get their way while not even reaping what they sowed through being blamed for failure of the stimulus plan. Brilliant campaigning, though for what it's worth I'm sure history books will judge them harshly.

Internationally, the outlook also didn't look great for the long term. Europe had many automatic stabilizers in place which fulfilled the same function that much of the US stimulus did (significant portions of the stimulus took the form of unemployment benefits and other policies that required no special authorization in Europe). However, they still had large problems with their banks, which weren't exactly handled with grace, and didn't have a particularly encouraging method of dealing with sovereign debt problems and other issues involving coordination within the EU. Export led growth on the part of some EU countries also had a bit of beggar thy neighbor feel, in a global crisis the main issue is getting the world out of a slump, trying to simply maintain your growth during the slump is an ultimately futile delaying tactic. An autarkic policy only makes sense if the rest of the world can pull itself out otherwise you get a temporary surge and sink back with the rest as the downturn continues.

This issue afflicted Chinese policy to some degree as well. Being a low cost competitor meant that what demand existed would shift in favor of China, combined with a very large and well targeted stimulus the Chinese have continued to do quite well through most of the downturn. There are however many recent reports showing at least some strain on the Chinese economy. From what I gather the Chinese policy failed in what it really needed to do to continue growing in a worldwide slump, shift more of its production to meet internal needs and increase consumer demand, both for domestic and foreign products. There is of course only so much government policy can do to achieve this but given the depth of the slump the Chinese government would have been wise to focus less on export led growth.

Of course, while there is plenty of blame to go around for mistakes made, this leaves the question of what to do now. This is much harder, the opportunity for effective policy is past so we're left with bad options. I personally favor a long run investment plan in infrastructure, including such goods as more mass transit, a smart grid, and a standardized electronic health infrastructure paired with long term revenue and expenditure reforms, namely a health care cost reform bill to put back in and add new cost reforms left out in the ACA, pollution taxes, defense cuts, and tax reform to streamline and rationalize the tax code. Just for kicks, lets throw in getting rid of mandated free parking. This isn't immediate stimulus, I think the time for that has passed, but instead long term reforms aimed at restoring confidence in the long term prospects for the economy (I don't buy the argument that long term confidence is a synonym for low taxes, real people need more well thought out plans that provide tangible ways forward).

Back to the NY Times article, I think the biggest flaw isn't so much in how we responded to the downturn, there was a lot of uncertainty so mistakes were inevitable, it's how we responded to the relatively good times of the decade before, though even then growth was historically slow hinting at unaddressed problems. This quote from the article is something I entirely agree with:

The I.M.F. has often prescribed austerity for countries in trouble, but last week two senior officials of the fund sought to slow the push for spending reductions in major economies. They challenged the perception that national budgets are in trouble because of the bailouts and fiscal stimulus programs that were enacted to combat the financial crisis.

“Today’s debt problems,” wrote Olivier J. Blanchard, the chief economist, and Carlo Cottarelli, the fund’s head of fiscal affairs, in an essay published in The Financial Times, “result not from how fiscal policy was managed during the crisis, but from how it was mismanaged before the crisis.”

Countries, they said, should have built up savings when times were good. The two officials argued for restraint in imposing austerity programs now, advocating the adoption of fiscal reforms that will have their largest impact in later years.

Something else I disagree with a bit:

Economics is a notoriously uncertain discipline. It is possible that a surprisingly strong employment report, or some other unanticipated event, could begin to disperse the fog of economic pessimism that has engulfed investors and sent interest rates to record lows.

Economics isn't nearly as uncertain as it's made out to be. I think it's more accurately described as being quite certain on a number of politically inconvenient ideas and very uncertain about a number of politically convenient ones. In many cases, it's also usually a small number of hold outs from schools of thought marginal to the discipline as whole that are dissenting in favor of a politically convenient set of concepts while the majority of the discipline is saying hogwash to those notions.

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