Here's Paul Krugman:
Sooner or later, then, consumers were going to have to pull in their belts. But the timing of the new sobriety is deeply unfortunate. One is tempted to echo St. Augustine’s plea: “Grant me chastity and continence, but not yet.” For consumers are cutting back just as the U.S. economy has fallen into a liquidity trap — a situation in which the Federal Reserve has lost its grip on the economy.
...The capitulation of the American consumer, then, is coming at a particularly bad time. But it’s no use whining. What we need is a policy response.
...[W]hat the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.
Tyler Cowen responds:
Krugman... calls for fiscal stimulus... I am more inclined to think that consumers need to cut their spending now. It is widely understood that consumers have been living beyond their means. Let us say instead that consumers maintain their spending (say through fiscal stimulus, a cut in sales taxes, or sheer exhortation) but that everyone knows consumer spending will fall in three years time. In three years time, the "liquidity trap" (not exactly how I think of it) will be over, but in the meantime investment commitments will be lackluster, given that people will be waiting for the economy to digest the forthcoming change. Maybe we need to spend less now and get the adjustment over with more quickly, even though that will be painful.
I love this exchange, because it beautifully dances around the elephant that is not in the room.
Krugman's point is that, ordinarily, a dip in consumer spending could be offset by an investment boom, courtesy of the Federal Reserve. As always, there's a model just behind Dr. Krugman's words, summarized in this case by an accounting identity:
Y = C + I + G + NX
If C (consumer spending) contracts, and I (investment) cannot be made to grow, then, ceteris paribus Y (GDP — truth, goodness, and happiness) must fall, unless we start messing with G (government spending) and NX (net exports). Hoping for an export boom during a global recession seems daft (although NX shifting toward zero from recent negative values may help), so we are left to work with G. It's time to ramp up government spending.
You can almost hear the words of Hayek echoing in Dr. Cowen's rejoinder: "Mr. Keynes' Krugman's aggregates conceal the most fundamental mechanisms of change." Cowen's rather subtle point is that if we artificially support current patterns of consumption by having the government spend money into people's pockets, we won't know what future, sustainable patterns of consumption might look like. Without that, we won't know what to invest in. Paradoxically, we might exacerbate the short-term problem by suppressing private investment. We cannot run the economy off of government spending indefinitely, and if we just postpone the pain, we will find ourselves with fewer resources when we have to deal with the underlying problem.
The elephant that is not in the room is a financial system. By a financial system, I don't mean the tottering cartel of banks and insurers loudly sucking newly printed cash into "collateral postings" and "deleveragings" and other meaningless nonactivities. That is no financial system at all. It is an ecology of intestines and tapeworms, tubes through which dollars flow and are skimmed en route to destinations about which the tripe-creatures have little interest or concern.
No, a financial system would be forward-looking. A financial system would be interested in the world, rather than fascinated by the patterns that formed behind its own mathematical eyelids. A financial system would hunger for information. It would leave no human preference overlooked and no technological possibility unconsidered. A financial system would embrace us all, would want to learn from us all. It would not be something external, something outsourced to specialists in London or Manhattan. It would want "savers" to express what they plan to do, how they hope to live, rather than offering generic claims on money along a disembodied spectrum of "risk". It would thirst for proposals, ideas, business plans designed to meet the preferences thus expressed, or to achieve possibilities not widely considered. A financial system would be creative. No stock exchange could contain the vast and multifarious tapestry of investable ideas a financial system would educe. A financial system would offer us opportunities to invest not in distant opportunities where we are disadvantaged, but in projects that are informationally, if not physically, near to us. A financial system would be ruthless. It would allow us to have a voice in the most important decision we collectively make, but would force us each to bear the costs of our errors.
We simply do not have such a system. We don't have anything remotely like such a system.
If we did, Dr. Krugman's preferred remedy would have worked five years ago, when the Fed still could, and did, stimulate an investment boom. If we had a financial system, we would not have invested in luxury housing and disinvested from tradables while our current account deficit ballooned. We would not have securitized current consumption, and then called it "investment". Extrapolation is not foresight, and Ponzi schemes do not generate wealth. We did not have a financial system in 2003. That is how we got to 2008.
If we had a financial system, we wouldn't require the world economy to collapse, just so we could learn how it might be put back together again (with expectations sufficiently lowered). Our financial system would be considering a wide array of possible futures, and using us all to push the world toward to a future that actually makes sense. If we had a financial system, we would be saving by spending to enable future production, not by making sure our dollars are in the kind of bank accounts the government guarantees. Strained consumers would shift from C to I without depleting Y, by purchasing claims on future goods and services, which investors would sell while funding projects designed to ensure the production of those goods. The very act of cutting back current consumption would generate new information about the structure of future consumption, as nervous savers factor price into claims on the future and nervous investors compete to offer claims at prices low enough to sell but high enough that they can ensure profitable fulfillment through an uncertain future.
Of course, this is a kind of dumb utopianism. If we had a magic wand, we'd have better options too. But I suggest you look at it the other way around: the "financial system" that we actually have is an awful dystopia. Yes, it will be impossible to create the perfect massively decentralized optimizer of collective and individual human futures. Screw perfection, but we should at least go for mediocre. Right now, banks don't even bother to sell themselves to savers on the basis of their superior acumen in choosing real investments. Investors in mortgage-backed securities never believed there was a deficiency of luxury exurban housing. People don't invest in index funds because they have a considered belief that the projects available to listed firms are superior on average to other projects that might be pursued. We have methodically erased information about real-world activities from the financial decision-making process. We've created an intrafinancial mandarin class, treated as experts, entrusted with wealth, but lacking knowledge of anything other than the arcane wheels and gears of finance, as if the finance exists apart from the workaday world of producing and consuming, serving and being served.
There will never be a perfect financial system. But the system we have is so far from reasonable that it must be undone, or it will be our undoing. We should not be propping it up. We should be tearing it down, and using all these hundreds of billions of dollars to replace it with something sensible.
By the way, as a policy matter, in this world as it is, I don't mean to criticize either Krugman or Cowen. I think they are both right. Per Krugman, for now we have little choice but to have government do a lot of spending, since we have no financial system to convert present savings into real investment. But, for the reasons that Cowen highlights, I think we should channel any stimulus towards basic consumption by those facing hardship (e.g. unemployment benefits, food stamps, etc.) and obviously necessary infrastructure investment (fixing bridges, dams, power grids, etc.). In any reasonable future, everybody will eat, so offering money to those struggling to put food on their table or a roof over their heads will create less uncertainty about future tradeoffs than subsidizing discretionary consumption by those better off. And it's a cliche, but a true cliche, that our public infrastructure is crumbling. Pulling forward restoration projects that will be necessary unless there are radical changes in the structure of American life also introduces relatively little noise.
But the most important thing we should be doing is building a real financial system.
This article has 10 comments:
not that one.
In a free market based on private property, private contract, private savings, there is no "financial system" as such. It's easy to baffle the public and conflate markets with intervention (liberty and fascism), using muzzy terms like "financial system" to imply it's all one big intertwined Political Economy that needs alternating doses of poison and free lunch.
Once in a while I'd like to hear a notable economist say that GSEs were lunatic bipartisan folly, that central banking makes as much sense as Soviet central planning, and unfunded entitlements have to be wound up and written off -- all of them, including private pension and health care funds that are hopelessly broke (auto workers, teachers, cops, airline pilots, etc).
What we are doing is what Japan did. Falsely prop up the system and refuse to fix anything as the economy collapses. Then falsley prop up banks, socialize industry, and let people artificially price the assets that got them in trouble. For Japan it was real estate. For the US it's real estate and derivatives. So far we have almost 0 reforms on real estate or derivatives. We also are letting banks hide their losses and proping up failed, inefficient institutions like Goldman Sacs which is where the Paulson the head of the Treasury is from. How convenient.
Cut the corruption, kill the bad companies leeching off the economy and now the taxpayers. Regulate to kill the bad derivatives and overleveraged banking games, re-institute Glass Stegal if you have to. Then, and only then, pump a lot o G into the economy.
What we have instead is a casino.
Money flowing "to" the intermediaries (non-banks) actually never leaves the com. banking system as anybody who has applied double-entry bookkeeping on a national scale should know. The growth of the intermediaries/non-ban... cannot be at the expense of the com. banks. And why should the banks pay for something they already have? I.e., interest on time deposits.
Dr. Leland James Pritchard (MS, statistics - Syracuse, Ph.D, Economics - Chicago, 1933) described stagflation before it's development -- 1958 Money & Banking Houghton Mifflin,
“Profit or Loss from Time Deposit Banking” -- Banking and Monetary Studies, Comptroller of the Currency, United States Treasury Department, Irwin, 1963, pp. 369-386.
So government spending increases GDP. But government spending, theoretically, comes from taxes, which reduces consumption by the same amount. Oh, silly me, that's right, we borrow a lot of G, don't we? And that comes from a negative NX, net exports, which in turn feeds C.
At what point does Gross Domestic Product actually reflect production?
Rhetorically: How do you (or anyone) plan to subsidize unemployment and launch make-work programs of massive scale (and questionable value) without inflating the price of labor? And how will this aid an economy already reeling from debt and expenses? How will leaching private savings in order to pay for these programs - via tax or bond - help solve our central problem, which is, we don't save enough? And how do we do any of this without further destroying the dollar and, with it, our economic future?
Build a new financial system? Ye gads, man, let's learn a little biology before we go building hearts.