The National Journal asks: “Is the Obama administration’s stimulus plan helping to create or “save” 650,000 jobs, as the president and his aides say? Is that an appropriate way to measure the stimulus’ impact?”

My response:

I am astounded by claims that fiscal stimulus under recession circumstances doesn’t create jobs. Or at least I am astounded when such claims come even from some reputable economists.  Do they think that a construction job on a road-building project doesn’t count as a real job if the funding comes from the government?   More likely, they think that the increase in demand doesn’t raise output in the aggregate, because the federal debt crowds out private production and so someone else somewhere loses his or her job?  But that would be hard to believe, at a time when the Fed is keeping interest rates at zero, long-term interest rates are also quite low, and capacity is lying idle.  Moreover, Republican lectures to Democrats about the evils of the national debt take real chutzpah, after Presidents Reagan, Bush I and Bush II increased the debt ten-fold during periods when no national emergency required it.

Yes, the effort to identify specific jobs saved is more a political exercise than an economics exercise; but the true number of jobs saved, relative to what would otherwise have happened , is greater than the 650,000 number. It is legitimate as a communications strategy for the White House to make the benefits concrete by pointing to the many individual teachers who would have been laid off by fiscally devastated state and local governments in the absence of federal government money. But there are several difficulties with using this job count as a way to evaluate the impact of the fiscal stimulus.  One problem is that the exercise doesn’t count the indirect effects of most of the spending and tax cuts, where it is hopeless to try to pinpoint whose job was saved.

The biggest problem, of course, is that one cannot estimate accurately, let alone prove to the skeptics, what would have happened in the absence of the stimulus package. Claims by Republican congressmen that one should judge Obamanomics by looking at whether employment is greater now than before February are nonsense. If there hadn’t been a severe recession underway (starting on the predecessor’s watch, if you want to get political about it), there would have been no need for the stimulus. None of us claims that fiscal stimulus creates a lot of jobs on net when the economy is already expanding strongly. The increased government spending that occurred during the terms of Presidents Reagan and Bush after the recessions of their respective first terms had already ended, for example, did not create a lot of jobs.  But without the recent stimulus, the recession would have been worse.

The appropriate way to estimate the stimulus impacts is by means of a standard macroeconomic model with fiscal multipliers in it. But if you believe philosophically that fiscal multipliers are zero, even in a severe recession, then neither a standard macroeconomic model nor anything else will convince you.

Friday marks 200 days in office for President Obama.   “How has he done?” asks Fortune.

The first thing to say is that Barack Obama took over the presidency at an extremely difficult time. A variety of analogies suggest themselves: He is Harry Houdini who has been thrown in the river, in a straitjacket, with chains wrapped around him. Or he has taken over as the captain of a ship with a rotting hull, while the ship is under attack in a hurricane. To capture the state of the economy, perhaps the best metaphor is that Obama took over as pilot of an airplane in the middle of a steep dive. For a president precedent, he is Lincoln, who takes office as the South secedes. Or he is Roosevelt, who takes office at the depth of the Great Depression.

In any case, in light of the difficult circumstances, I think Obama has done amazingly well.

The financial markets were in free-fall six months ago. Bank spreads were at historic highs (a good indicator of just how outside-the-box this financial crisis was). GDP contracted at an annual rate of about 6 % in the last quarter of 2008 and the first quarter of this year.

Since then, the airplane has begun to level off. Those bank spreads are down to more normal levels. GDP declined at an annual rate of “only” 1% according to last Friday’s advance estimate; if I had to guess, we will see a bottom in the second half of the year and could see some positive growth. I give a lot of credit to the fiscal stimulus, to the monetary stimulus, and to the financial repair measures, as messy as those inevitably were.

At the time our new president took office in January, there was a danger that this could be not only the worst of the post-war recessions, but as bad as Japan in the 1990s. I think we have now avoided that. We have learned from mistakes in the past, particularly the mistakes of the Depression – those made by the Federal Reserve, Hoover, and also Roosevelt. Obama has the advantage of the lessons of the 1930s to learn from.   But he has the disadvantage of having inherited an exploding path of debt (unnecessarily incurred by this predecessor).    The debt is the rotting hull of the ship of state.

Regarding February’s stimulus package, some commentators said it was too small, some said it was too large.  In truth, it was both.   It was too small by itself to return us to full employment, to knock out the recession.   In order to bring us back to full employment, we would  need a boost to spending several times as big.  And yet, at the same time, it was too large to guarantee that we avoid losing the confidence of our international creditors.   If they stop buying our bonds, US long-term interest rates could rise sharply.   (China — the largest holder of US Treasuiy securities — has already begun to ask questions about the value of US debt.)     But the Administration struck an appropriate balance between these two competing concerns. 

People are angry about the big bonuses that are still being paid to those in the financial sector who got us into this problem. Entirely understandable. But don’t forget that, from the beginning, the goal was to prevent a depression in the general economy. That has been accomplished. You don’t punish someone who has been smoking in bed by allowing the resultant fire to burn down the block. The Administration and the Fed always admitted freely that helping some undeserving financiers would be an undesirable but necessary side effect of the rescue plan. And do you remember all the pundits who warned that the rescue could not work unless the banks were temporarily nationalized? Or all the cynics who dismissed claims that the Treasury would recoup a share of the budget costs as firms like Goldman Sachs repaid their loans with interest?

In my view, overall, Obama has gotten far more things right than wrong. He has bravely proposed things that most sensible economists — whether Republican or Democrat — have long favored. Proposing is not always the same as enacting; there is the matter of Congress. But he has tried to get them passed, and has tried to do it in a bipartisan way.  (That bipartisanship constraint is one of the Houdini chains.)

Washington has always been stymied by the political constraints of what can pass Congress.  Often presidents figure that special interest groups will block sensible reforms, so why waste political capital trying? But an example, which I find extremely encouraging, including symbolically, is that (with the help of Defense Secretary Robert Gates), Obama proposed to end spending on the F22 fighter. The F22 is probably the most egregious example in the defense budget of spending on hugely expensive weapons systems that the Pentagon doesn’t want because they are not useful for today’s national security needs. To my surprise, Obama actually prevailed  on this.

I can also name two areas where he proposed very sensible legislation that a heavy majority of economists of both parties would support, and yet where he has lost in Congress (at least so far). One is cutting agricultural subsidies to agribusiness and rich farmers. Another is auctioning off most of the greenhouse gas emission permits in any plan like the Waxman-Markey Bill, rather than giving them away to industry.  (Obama’s proposal was to use the proceeds of the auctions to reduce the marginal tax rate on low-income workers, to “Make Work Pay,” which would have been an excellent use of the funds.)

But the fact that he is trying, and that he is winning some of the battles, is important.  He is willing to fight the fight, while yet compromising when politically necessary. It is tremendously important that the public take notice of these details. There are always particular interest groups that stand to lose from any given reform such as farm supports,  military procurement or emission permit auctions; if the general public pays no attention to the details and does not support the President on them, it means special interests will triumph over the general good as so often in the past.

If I had to find one mistake that the White House has made, the initial economic forecasts were too optimistic, at least with respect to the unemployment rate. It was an honest mistake, but a mistake nonetheless… not just with respect to the economics: politically, Obama would have been better to recognize the severity of the recession from day one.

Regarding the health plan, we as yet have no idea what the outcome will be. The big questions, of course, are how to reduce costs and how to pay for getting everybody insured. Instead of proposing an income surcharge on the wealthy, I would have preferred eliminating non-taxability of employer-provided health benefits— that’s what McCain was for in the campaign, and most economists as well. The non-taxability could have been retained for workers in lower income brackets if the White House felt this was essential.  At the least, Senator Kerry’s astute version, which is aimed at curbing the effective taxpayer subsidy in the cases of the most egregiously expensive health care insurers, should be politically saleable.   You can call Obama’s failure, so far, to move in this direction a second mistake. But, since Fortune asked my opinion of how much the President has done right versus wrong, I put the score at 98 to 2. 

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Personal saving rose again in the second quarter. “Does this mean the stimulus tax cut has failed, as the 2008 tax cut stimulus did?”, asks The National Journal.

My answer:

Martin Feldstein and others predicted that the tax-cut component of the 2009 fiscal stimulus package would have substantially less expansionary bang-for-the-buck than the spending component of the package, because much of the tax cut would be saved, as had been the case with the 2008 tax cut.  (“Bang for the buck” in this case could be defined as demand stimulus divided by budget cost.)   We knew this from Milton Friedman’s permanent income hypothesis, or even from good old Keynesian multiplier theory.

But in February President Obama had to get those last three (Republican) votes to pass the stimulus bill in the Senate, and those three Senators insisted on raising the tax cut component of the stimulus package a bit and lowering the spending component. Their motivation presumably was to mollify their fellow Republicans, many of whom still claim that ONLY tax cuts provide stimulus, and that spending does not (and perhaps even has a negative effect) — which is even more extreme than the claim that a tax cut creates stimulus equal to spending. After the failures of the Bush tax cuts (and Reagan’s before him), I don’t know if any economists still cling to such “supply sider” notions — or indeed if these congressmen would be able to state their logic. Regardless, I think the Feldstein prediction has been borne out since then.   Talk about irony!   The Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03 were both explicitly designed to boost saving — hence their focus on capital income and higher income brackets — and yet in both cases private saving fell in their aftermath.   The tax cuts of January 2008 and February 2009 were both explicitly designed to boost consumption; yet private saving rose in their aftermath !   

Fortunately, the majority of the Obama stimulus package took the form of increased spending, much of which has yet to come.

None of this is to deny that efficiency is an important consideration, and cost-benefit calculations should always enter into the choice of both what kind of tax cuts to adopt and what kind of spending increases to adopt. But if it is short-term demand stimulus we are after, and we are, then government spending gives more bang for the buck than tax cuts.

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Most international summit meetings are long on photo-opportunities and short on substance.   There was a great danger that last Thursday’s G-20 meeting in London would be merit comparison to the failed World Economic Conference of 1933, which was also held in London.   This one, however, did have genuine substance.   

Nobody reads the communiques, or listens to the press conferences of leaders or finance ministers. But here is the substance:

Top of the list of accomplishments was expansion of IMF resources. The new SDR allocation was perhaps the most noteworthy and unexpected decision: those observers who have proposed such a step in the current international crisis, or in past international crises, have usually been dismissed as pipe-dreamers (John Williamson, Dani Rodrik, George Soros, Joe Stiglitz…). In addition, there seems to have been some forward movement on international regulation of the financial sector, as the Europeans wanted. Although President Obama acquitted himself well overall, the failure to achieve agreement for coordinated additional fiscal stimulus, as the Americans wanted, was probably the greatest shortcoming of the meeting.

I believe the G-20 meeting will be remembered historically, but not primarily for the above reasons. It will be remembered as the occasion on which primary emphasis shifted from the G-7, the global steering group that until now has had a monopoly on real economic decision-making power, to the G-20. Of the various substantive ways in which developing countries could and should have been given more representation in recent years, the shift to the G-20 is the first one to have actually taken place.

          Now I am a believer.    

Few readers of my blog will be surprised to hear that I voted for Barack Obama in the election.   But I was always skeptical that he would be able to achieve fully his promises to bring candor, responsibility, and bipartisanship to Washington.    Experience had convinced me it wasn’t practical.   OK, I am still dubious whether it is possible to achieve bipartisanship – even for Obama.    The evidence was his failure a week ago to get a single Republican vote for his fiscal stimulus in the House (and only three votes in the Senate) despite his substantial election mandate, 63% approval rating, the severity of the current recession, and the concessions he made to the other side.    

When it comes to honesty and responsibility, however, what Obama did at his Fiscal Responsibility Summit today was breathtaking.    (more…)

          We often hear the question “isn’t this economic crisis becoming as bad as the Great Depression?” Economists can offer a variety of reassurances, but each of them is quite circumscribed:
(more…)

           Congress has finally agreed on a $790 billion stimulus package.   Is it too small, as many Democrats claim (such as Paul Krugman), or too big, as many Republicans claim (such as the minority party leadership in Congress)?     The answer is yes.     It is too big and too small.

(more…)

It is unfortunate that much of the congressional debate regarding the stimulus package is phrased in terms of a summary statistic: what fraction of the stimulus is to be increased spending and what fraction is to be tax cuts. It currently looks to be about 70-30, but the Republicans say they want more in tax cuts and the Democratic holdouts say they want more in spending.

To judge the merits, one has to go into greater detail. (more…)

The members of the G-20 are meeting in Washington on November 15 to discuss reform of the global financial system.  The first thing to say about the calls for a “new Bretton Woods” is that they overreach, in the sense that it is very unlikely that any changes in the structure of the international monetary or financial system will or should, at this point in history, come out of multilateral discussions that are big enough to merit comparison with the first Bretton Woods. Certainly we are not talking about fixing exchange rates, as the 1944 meeting did.

Detour for an anecdote.  In mid-1998, when the crisis that originated in Southeast Asia had reached its one-year anniversary without abating, President Bill Clinton decided to give two important speeches.   He wanted to call for a new Bretton Woods.   His economic advisers (including both at Treasury and in the White House) advised him against this, on the grounds that one should not call for something as portentous as a new Bretton Woods when one was not likely to have proposals substantive enough to merit the name.   Soon after the (successful) speeches, British PM Tony Blair called for a new Bretton Woods.    Clinton asked his advisers, “How come Blair got to call for a new Bretton Woods when you wouldn’t let me do it?”    Our answer was along the lines, “Blair’s Treasury Secretary, Gordon Brown, doe s not necessarily have his interests aligned with his boss, in the way that Bob Rubin does.   So Brown had less incentive to stop Blair from saying something foolish.”   The big irony of the story is that Brown today is himself leading the move for a “new Bretton Woods.”

Even though the effort is virtually certain to fall short of a true “Bretton Woods 2,” it is worth taking the opportunity to consider what changes – whether more ambitious or less — might be made at the multilateral level to improve the functioning of the system.

Changes in government policy at the national level have already been radical in many countries, compared to anything that would have been imagined a short time ago:
• central banks’ extension of credit to institutions and under terms not contemplated in the past,
• governments’ buying up bad assets and recapitalizing, taking over,, or otherwise transforming troubled banks and financial institutions),
• agencies guaranteeing deposits (without limit) and money market funds, and so on.

Some of these steps can be done at the purely domestic level (US takeover of Fannie Mae and Freddie Mac); others require cooperation between a small number of countries (rescue of Fortis by Benelux countries); but others arguably require multilateral agreement, and thus are candidates for a modest “Bretton Woods.”

•  The International Monetary Fund has been given the task of outlining what a new Bretton Woods would look like – appropriate since the IMF is one of the original Bretton Woods institutions (along with the World Bank).
      o An Early Warning system is almost certain to be high on its list. But it already developed early warning indicators, after the East Asia crisis of 1997-98, and they haven’t been much help.
      o Now that the financial crisis is spreading to small economies like Iceland, transition economies in easternmost Europe, and poor countries like Pakistan, the IMF country rescue programs will get back in the saddle.
           This time around, however, the Fund has more competition (including from the ECB, the Gulf countries, China, and Sovereign Wealth Funds), and partly for that reason will probably demand less conditionality from the borrowing countries.    Also the Fund will have to turn to newly-wealthy countries like China to help finance  new facilities and programs.
              • Bill Rhodes has proposed that the Fund facilitate expansion of currency swap arrangements, to allow emerging markets to have the same access that has been made available to developing countries.
              • Michael Bordo and Harold James have suggested that the Fund could manage reserve assets of the new surplus countries; but it is not clear why the latter should want it to.
          The Contingent Credit Lines (CCL) – which were launched by the IMF with some fanfare in the aftermath of the 1997-98 East Asian crisis but were never attractive enough to attract a single client country — are back now, in the form of  new Short-Term Lending Facility.  The idea has always been that countries that have followed blameless policy (or as far as we can come to that in the real world), as judged by pre-crisis criteria, should be able to borrow large amounts from the Fund very quickly when faced with global contagion, without the usual conditionality.    Brazil and Korea look like two countries that had done most things right in recent years (flexible exchange rates, high level of reserves…) and have nevertheless since September seen international investors disappear.    The IMF has responded appropriately, with CCL-type loans that are multiples of country quotas.  
          Only a small number of countries qualify for having followed “blameless policy.”  Morris Goldstein suggests that the larger class of countries that have now been hit by forces beyond their control — the US-originating financial crisis — be helped by a revival of a long-ago IMF loan window, the Compensatory Financing Facility.
• The problem is that the money that the IMF is now able to offer is not only small relative to global capital markets (the IMF has long been used to that circumstance), but also small relative to the countries’ own reserves or to the no-condition funds that the Federal Reserve has now offered them through swap lines.   To expand such facilities, the IMF needs more funding.  Where will it come from?  Sovereign Wealth Funds and central banks in East Asia and Gulf countries.   But that in turn requires giving these countries much greater political representation than they currently have in the Fund.
              o There has been a loose one-year campaign to suggest guidelines for the operations of Sovereign Wealth Funds themselves, to “regulate” them.  But benefits of the SWFs may be more widely appreciated now than a year ago, in the context of the current crisis.   
              o The IMF, just as all the multilateral economic institutions, has moved far too slowly to give added representation to the newly important developing countries such as China, Brazil, Korea, India and Mexico – representation at least in proportion to their economic role, to say nothing of population.
                  A big part of the problem is that larger quotas and voting shares for these countries would have to come to a substantial extent out of Europe’s share.
                  In a fair world, Europe would also give up its stranglehold on the Managing Directorship (especially after the performance of the recent incumbents, who have appeared less interested in their jobs than in domestic politics back in their home countries or in putting new meaning into the phrase “foreign affairs”).  The same goes for the U.S with respect to the World Bank presidency.

•  The G-8 has been increasingly handicapped in recent years by virtue of its obsolete membership.
      o The G-7 still retains some relevance, in its role as self-appointed steering committee for world governance. After all, this financial crisis did not start in the developing countries, as it did those of 1982, 1997 and 2001.
     o But the G-7 cannot discuss the spread of the crisis to developing countries without Korea, Brazil, Turkey, India and Mexico at the table.  It cannot discuss central topics such as global current account imbalances, or the need for exchange rate adjustments, or coordinated global fiscal expansion, or requests that surplus countries fund rescue programs,  without China and Saudi Arabia at the table.     Thus it is appropriate that the G-20 is the group that has been invited to to the November 15 summit in Washington to discuss the new Bretton Woods.   
     o  Coordinated fiscal expansion is the most likely substantive macroeconomic policy outcome of the G-20 meeting.
      
• A probable substantive structural outcome from talk of the need for a bold new multilateral initiative is that there could be a “Basel III” to replace the “Basel II” agreement.
      o It would make capital requirements on banks countercyclical, rather than what has turned out to be procyclical, i.e., destabilizing, under Basel II. (Ironically economists at the BIS in Basel probably deserve credit for being the observers, in addition to Charles Goodhart, who most accurately warned of the procyclicality before the crisis.)
      o A Basel III could also replace the option of self-regulation of banks (under which they could choose their own Value At Risk models) with external regulation.    Dan Tarullo, who could have a  major role on the Obama team, offers some ideas .
      o The highly capable chairman of the Financial Stabilty Forum, Mario Draghi, assures us that already this year substantial progress has been made in such important areas as reducing conflict of interest on the part of credit-rating agencies.
      o International guidelines for guaranteeing deposits (possibly reinstating a ceiling, such as $100,000, after the crisis has passed) should perhaps be coordinated, to avoid flight of the sort that Ireland’s European partners experienced.

• Other possibilities:
      o A more ambitious reform would be to try to agree on guidelines to extend prudential regulation from international banks to non-bank financial institutions, since the latter were such a serious part of the problem in 2008 that many either failed or were bailed out, against all expectations.
      o More radically, regulation of this sort not just agreed multilaterally but carried out multilaterally, rather than at the national level, by the BIS (which now includes major emerging market countries) or a new agency.
      o The IMF, Financial Stability Forum, and other institutions will vie to lead the effort.
      o Other proposals, many of which could be attempted at the national level, but would optimally be coordinated internationally:
           A securities transactions tax, harmonized internationally, to raise revenue in a way that satisfies the public’s understandable feeling that the financial sector, which created this financial crisis, should not benefit from the solution.
           Executive compensation reform (especially in the financial sector).   Options-based bonuses have not been implemented in the incentive-compatible way that the corporate finance theorists anticipate  d, and have instead encouraged inordinate risk-taking.  One possible solution is to discourage compensation by options, in favor of restricted stock.    Another is to regulate corporate governance so as to insure that the CEO’s buddies don’t comprise the committee that determines his or her compensation.
         Regulation of the “originate to distribute” model of mortgage lending. Mortgage-Backed Securities were a useful innovation, but were carried too far.  The banks or mortgage brokers that originate a mortgage loan should be required to reattain a certain slice of each one (some have suggested 1/5), before selling the rest on, so that they have an incentive to monitor the creditworthiness of the borrower.  
           Regulation of Collateralized Debt Obligations.   Perhaps it is enough to raise capital requirement on the holders.  Perhaps something more drastic is required. 
           Regulation of certain derivatives, particularly Credit Default Swaps.  Perhaps it would be enough to standardize CDSs and set up a central clearing house, as many observers have suggested.
           But there is a danger that derivatives regulation could do more harm than good, e.g., a ban on futures markets or short-selling.
  o At the other end of the spectrum, one should consider the possibility that doing nothing might in the end be better than undertaking fundamental reforms in the international financial system, if the latter were driven by clumsy politics.

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