I’ve been on whatever planet I go to when I’m not writing. Don’t ask, your guess is as good as mine.
When I checked out out a few weeks ago, there was a debate raging on “fiscal austerity”. Checking back in, it continues to rage. In the course of about a half an hour, I’ve read about ten posts on the subject. See e.g. Martin Wolf and Yves Smith, Mike Konczal, and just about everything Paul Krugman has written lately. While I’ve been writing, Tyler Cowen has a new post, which is fantastic. Mark Thoma has delightfully named one side of the debate the “austerians”. Surely someone can come up with a cleverly risqué coinage for those in favor of stimulus?
Here are some obvious points:
Austerity is stupid. Austerity is first-order stupid whenever there are people to whom the opportunity cost of providing goods and services that others desire is negative. To some economists, that sentence is a non sequitur. After all, nothing prevents people from providing goods and services for free, if doing the work is more beneficial to them than alternative uses of their time right? Economists who make this argument need to get out more. Doing paid work has social meaning beyond the fact of the activity, and doing what is ordinarily paid work for free has a very different social meaning. It is perfectly possible, and perfectly common, that a person’s gains from doing work are greater than their total pay, so that in theory you could confiscate their wages or pay them nothing and they would still do the job. But in practice, you can’t do that, because if you don’t actually pay them, it is no longer paid work. The nonmonetary benefits of work are inconveniently bundled with a paycheck. Under this circumstance, having the government pay for the work is welfare improving unless the second-order costs of government spending exceed both the benefits to the worker in excess of pay and the benefit to consumers or users of the goods and services purchased.
Stimulus is dangerous. The second-order costs of government spending are real, and we are very far from being able to understand or estimate them. Here are some second order costs:
Transfers of relative purchasing power from other citizens to the beneficiaries of government spending may call into question the legitimacy of the distribution of opportunity, wealth, and influence and of the government itself. Perceptions of make-work or corrupt contracting are deeply corrosive. Deficit spending commits government to future transfers that may come to seem undesirable or illegitimate.
Government spending choices may lead to lower quality uses of real resources than would have occurred if the government had not acted. Since economic activity is habit forming and temporary interventions become permanent, the cost of poor government choices can be high. It matters very much what work the government is paying for. Work must be well-tailored to the talents, interests, and future prospects of individuals. Employing people badly is much worse than just giving them money.
If funds are spent, directly or indirectly, on resources in scarce supply, prices may be harmfully propped or bid up. That might take the form of a general inflation, or a narrower effect on the prices of specific commodities or assets.
High levels of government debt may have a destabilizing effect on prices, increasing price volatility and impairing economic calculation even in the absence of a general inflation, or even in a deflation. Government obligations are liquid and hypothecable, and the availability of good collateral increases the degree to which subjective changes in relative valuation translate to changes in nominal pricing.
There exist theories of government solvency which suggest that the safety and value of currency is related to the indebtedness of the issuing government. Those theories may or may not be reasonable. They may or may not find support in the historical record. Regardless, to the degree they are widespread, they may be self-fulfilling. Whether sensible or sunspot, loss of confidence in a currency is possible. Currency crises represent a “tail risk” whose likelihood and cost are difficult to estimate.
There are second order benefits to stimulus as well as costs: multipliers, consumer confidence, etc. But these are also difficult to estimate.
Lying is optimal. The debate among public officials about austerity cannot be taken at face value. Savers really could flee the euro, dollar, yen or yuan. Interest rates here or there could suddenly spike. A sudden dash to gold is possible. None of these financial market events would directly affect the real resources at our disposal, but any of them could devastate our ability to organize economic behavior, and would call into question the legitimacy of economic outcomes and the stability of governments. For policymakers who seek positive short-to-medium term outcomes, the optimal strategy is to avoid the first-order costs of austerity by spending and avoid second-order costs #1 and #5 by obfuscating their spending as much as possible. Costs #2, #3, and #4 tend to bite over the medium-to-long term, leading policymakers to discount them. I think we should expect a lot more austerity theater than actual austerity, for better and for worse. Expect central bankers especially to preach austerity while intervening madly in the shadows. That’s just what they do. By the same reasoning, we should expect policymakers to justify their actions with a lot of intuitive but awful theory. As the Modern Monetary Theorists remind us, the analogy between a fiat-currency-issuing government and a budget-constrained household is poor. It is, nevertheless, the framework under which most citizens and savers understand government accounts, and forms the basis of conventional discourse. Irrespective of what is a better or worse description of reality, it is safer for policymakers to frame their communication in terms of conventional theory than to promote a profoundly destabilizing paradigm shift. Expect President Obama to keep talking about how we are “out of money” even though he knows better.
Economic choices are not scalar. I think the austerity debate is unhelpful. There are complicated trade-offs associated with government spending. If the question is framed as “more” or “less”, reasonable people will disagree about costs and benefits that can’t be measured. Even in a depression, cutting expenditures to entrenched interests that make poor use of real resources can be beneficial. Even in a boom, high value public goods can be worth their cost in whatever private activity is crowded out to purchase them. Rather than focusing on “how much to spend”, we should be thinking about “what to do”. My views skew activist. I think there are lots of things government can and should do that would be fantastic. A “jobs bill”, however, or “stimulus” in the abstract, are not among them. If we do smart things, we will do well. If we do stupid things, or if we hope for markets to figure things out while nothing much gets done, the world will unravel beneath us. We have intellectual work to do that goes beyond choosing a deficit level. The austerity/stimulus debate is make-work for the chattering classes. It’s conspicuous cogitation that avoids the hard, simple questions. What, precisely, should we do that we are not yet doing? What are the things we do now that we should stop doing? And how can we make those changes without undermining the deep social infrastructure of our society, resources like legitimacy, fairness, and trust?
FD: I’m long precious metals and short long-term Treasuries. (My exposure to both is primarily via futures.) So perhaps I am thinking my book when I take the tail risk of currency crises more seriously than others do.
You don’t need to apologize for not writing. If you write once a week on average it’s optimal for me. I hate blogs that post five times a day and you have to separate the wheat from the chaff. Your stuff is always very insightful and time-saving :-P
Keep going
Long precious metals I understand. (Although when both L. Kudlow and J. Cramer are pumping gold, it sure is hard not to sell.)
But short Treasuries? That is not a hedge against a “currency crisis”; that is a hedge against a dollar crisis. Any other form of currency crisis could easily drive long-duration Treasurys to all-time low yields…
Dollar collapse is the Ultimate Crisis, and of course it will happen eventually. I just think we have a few more non-dollar crises ahead before we get there.
FD: Long precious metals (GLD) and long-term Treasuries (EDV).
“…for those in favor of stimulus?” – stimulustful?
Steve,
I haven’t commented in a while, but I emailed you about a broad commodity bust back on June 30, 2008 (title “commodities”). I got a nice reply from you (thanks!) but I ended up being so busy that I never got back to you (sorry!).
If that quasi-call counts for anything, please hear to me now: Krugman is right (he was wrong about the oil bubble, and I said so at the time — I’m not a Krugman-is-always-right guy).
The austerians really are just a bunch of idiots (or being myopically self serving). Those second order costs are exactly that: second order and largely irrelevant, the least of anyone’s problems. The big money is not so stupid as to believe in the household analogy. Neither are US, British, Canadian, Australian, Chinese etc. gov and cb officials, when push comes to shove. Europe may be a different story, as I think that the leadership there may actually just be clueless. It really is something to behold.
I appreciate that you are trying to see both sides, but you are way too generous to the austerians. I think that trying to see both sides is clouding your judgement. If I were you, I would not be short long-term treasuries right now. I just don’t see what the upside is to that trade. If the euro crisis gets worse (a debt crisis, but not really a fully sovereign debt crisis) I imagine that Treasuries will do well.
How’s this for worthwhile stimulus: a massive gulf cleanup effort. Plenty of unemployed people and idle boats down there right now. Longer term: green energy. There’s no paucity of high npv public projects and idle resources right now.
#5 sounds way too mysterious for me. I’m sure you know those theories, but I’d like to clarify the point. If the debt gets too large to be paid via taxation, the government might decide to monetize it (pay by printing money) instead of defaulting. The larger the amount monetized, the more inflation will occur ceteris paribus. Default is deflationary, so if the government defaults, the currency could actually gain value. Overall, excellent post!
Haha! So now when politicians continue to do what they do best (lie), it will be best for everyone else as well as themselves! :)
“Austerity is first-order stupid whenever there are people to whom the opportunity cost of providing goods and services that others desire is negative.”
What is “Austerity” in this economic context? If a government permanently lowers the compensation of certain public employees by 10%, uses half the savings to hire additional workers, and the other half to adapt to lower revised expectations of future revenue – is that austere or stimulating? If the same is accomplished in real terms with inflation? In either case, if austere, would it fall into the “stupid category”?
There is a difference between making government budgets rationalized to a new understanding of what is reasonable and possible in reality, and radically adjusting downward the role of government in a society, or the absolute number of public employees. All this talk disdainful “austerity” seem to conflate the two different possibilities.
But what about stimulus that’s well spent. A great deal of the Obama stimulus was for very high return investments of the kind the pure free market will grossly underprovide or inefficiently provide due to long established in economics market problems like externalities, etc. Examples include billions for alternative energy (I’ve read this has revolutionized opportunities in alternative energy research), infrastructure, education, cancer research, and more.
can anyone recommend a book that covers the ideas and thinking in this post more extensively?
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