Politics of PK

Business Insider believes that Goldman embraces PK in their analysis. I don't see it.

In a study presented at the Brookings Panel on Economic Activity on March 22-23 in Washington D.C., Bradford DeLong and Lawrence Summers examine the effectiveness of fiscal policy in a depressed economy. Specifically, they use a simple model to explore the effects of fiscal stimulus in an environment when (1) monetary policy is constrained by the zero bound on nominal interest rates; and (2) a boost to output today brings longer-run benefits for the productive capacity of the economy (for example, by avoiding "scars" or "hysteresis" in the labor market). They call such an environment a "depressed" economy.

They reach two conclusions. First, while the fiscal multiplier is low, perhaps as low as zero, in a normal situation, fiscal stimulus today would be highly effective in affecting output both now and in the future. Second, temporary fiscal stimulus could be self-financing (and may well reduce long-run debt-financing burdens) when one takes into account the effects of present stimulus on the evolution of future output and debt-to-GDP ratios.

The DeLong and Summers paper, unsurprising for two Democrats, only talks about higher Government spending (G), not higher deficits (G-T).

The "higher G" argument to "prime the pump" is K, not PK.

It's also fun to see how careful the authors are to remain on the good side of Monetarists, who continue to set the orthodoxy for macro. Does any of this sound like PK to you?

In normal times the logic of Taylor (2000) that stabilization policy should be left to the monetary authority still holds.

The fear is that expansionary fiscal policy will lead to a collapse in confidence in the government, and a spiking of interest and inflation rates to previously-unseen values.

Sovereign debt crises can be triggered by rises in spending due to expansion

All basic gold-standard stuff.

Recapitalize the non-Govt Sector, not the Financial Sector

When you have a credit bubble -- ie. banks make loans that do not get paid back -- then the subsequent credit bust de-capitalizes banks (as they must write down assets and equity) constraining their ability to lend anew.

As the non-government sector needs additional financial assets to grow, if banks cannot lend (capital constrained) then the economy as a whole starts to trouble.

This, in a nutshell, is where the "Too Big to Fail", "We Must Bail Out the Banks" argument comes from, and it is true, as far as it goes.

Nevertheless, there is more to the story. First, if banks were making loans that did not get paid back, then they were not doing their primary job which is to make good credit decisions. Bad credit decisions should be punished, and the owners and operators of such companies should be fired and/or wiped out. This is how markets work. Rewarding such behavior only encourages more bad practices in the future, and people (rightly) start to wonder why we have a financial system at all.

Second, if banks fail, that contraction in private financial asset growth can be balanced by "capitalizing" the rest of the non-Governmental sector directly (through some combination of tax cuts and spending increases -- whatever increases the deficit). Since economists at Harvard and Princeton do not understand that the Government is the sole creator of net financial assets (equity) for the private sector, they do not know that this policy lever is on the table. So we are where we are.

From Macroeconomic Resilience

My policy proposal has three legs all of which need to be implemented simultaneously:

* Allow Failure: Allow insolvent banks and financialised corporations to fail.
* The Helicopter Drop: Institute a system of direct transfers to individuals (a helicopter drop) to mitigate the deflationary fallout from bank failure.
* Entry of New Banks: Allow fast-track approvals of new banks to restore banking capacity in the economy.

The argument against allowing bank and corporate failure is that it will trigger off a catastrophic deflationary collapse in the economy while at the same time crippling the lending capacity available to businesses and households. The helicopter drop of direct transfers helps prevent a deflationary collapse and the entry of new banks helps maintain lending capacity thus negating both concerns.

Confusion on Greece

Megan McArdle's column highlights all the confusion going on in Greece right now. One commenter gets it right:

Jay wants to know why the Greeks should bother to leave the euro if they're going to default anyway:

My own belief is that Greece should exit the euro, and redenominate its debt in drachmae, which would constitute a de-facto default
In what way does changing currencies help? I mean, you're already defaulting.

Is the idea that you'll be able to inflate away future debts more easily? Who would buy Greek debt knowing that the only reason they are issued in Drachma instead of Euro is specifically because the Greeks intend to inflate it away?

Isn't this just the difference between nominal and real interest rates?

This is exactly correct. If Greece re-denominated the debt in drachmae it would constitute a default. It would also constitute a re-assertion of monetary sovereignty, and Greece would never have to worry about defaulting again, it would just need to worry about balancing unemployment against inflation. The better it gets at tax collection, the more it can better it can do at lowering unemployment without triggering inflation.

Mortgages (2004-2007) are not like normal loans

Megan argues that defaulting on your mortgage is not OK just because your house is underwater. Having the property secure the debt does not give you a free put option.

Ordinarily I would agree, but not for loans made during the housing bubble. During that time, lenders were not concerned about the borrowers ability to repay (see NINJA), but were, in collaboration with the borrower, making a bet on rising housing prices.

Since ability to repay was not part of the loan decision, there is no obligation to pay on the part of the borrower.

More on the yield curve, and Greece

Some further thoughts on recent posts (most of this is captured in the comments, but I thought I would bring it up as well).

1. Chartalists (or MMT) talk about "setting the yield curve to zero" by having the Government set a price (%) on bonds and issuing as many as is demanded, instead of what it does now which is sets a certain quantity, and then has the market clear to set the price.

In practice, because bonds get resold, and because they are not consumption goods (especially at short durations -- the value of a 3 month treasury note is not set by a downward sloping demand curve, it's set by its interest rate) the Government cannot actually increase or lower price by adjusting the quantity.

However, for longer durations, the willingness to pay for a bond depends on what the individuals inflation expectations are, and therefore I can see a distribution of expectations, and therefore a spread in willingness to pay. This would create a downward sloping demand curve and the Govt could set the price by adjusting quantity. Therefore, at longer durations I believe bonds would act as consumption goods in this sense.

Still, the most sensible approach would be to eliminate bond issuance entirely. It's a remnant of our gold standard days.

2. The Greek Central Bank can credit and debit accounts by simply marking them up or down -- just like the Federal Reserve, and unlike US States. Therefore, the eurozone is more like a cluster of multiple currency issuers who restrict money creation by... political rules (like the 3% limits). I'm actually not sure how fiscal discipline is imposed, formally or informally. If anyone has a succinct answer, please note it in the comments!