Monday, August 3, 2009

Recall the stimulus! (3)

Since early June I've been arguing that Congress should recall/cancel the stimulus bill passed in February. The recession started winding down right around the time the bill was passed, and now we're in recovery mode (see prior post today on the ISM index), all without the help of 90% of the "stimulus" spending. Indeed, the economy is now recovering despite the efforts of Obama and the Congress to scare the bejeebers out of the capital markets by threatening massive increases in government spending, regulations, and taxes. If the economy is strong enough to shrug off these powerful depressants, just imagine how strong it might be if we just let it do its own thing?

The economy doesn't need any help from Congress. On the contrary, it would be much better off if Congress remained in recess for the remainder of the year.


Paul said...

Anecdotally, I spoke to one of the managers at the large corporation I work for. He said the travel division, one of the hardest hit sectors, is turning around is actually starting to hire again.

Cabodog said...

Scott, any chance of a beer summit for you and Obama?

Scott Grannis said...

I prefer wine...

W.E. Heasley said...

You are exactly correct.

Every since you posted your first article on recalling the Quasi Stimulus Plan (believe Larry Kudlow of CNBC echoed the idea as well) the critical examination of the Stimulus Plan has accelerated.

Apparently “Size Matters” was the theme of the Quasi Stimulus Plan. The architects forgot that “Design Matters” too.

(1) Simultaneously deploying the theory of Keynesian Deficit Government Spending and the theory of Quantitative Easing, in a current environment of High Existing Government Debit (remember both theories were developed in an environment of zero or low government debt), it becomes a very dicey project (Japan 2001-2006). Japan is experiencing a 20 year down turn/recession,

(2) It would be extremely important, if deploying Keynesian Deficit spending:

(a) never base the plan on Political-Political, rather base the plan on Political-Economy,

(b) use the historical format of Infrastructure Spending rather than Social Engineering,

(3) If one deploys Keynesian Deficit Government spending, then at the very least understand what Keynes said: Deficit Government Spending is temporary until the Private Sector Recovers.

(4) Exactly what policies exist to create incentives for Private Capital Formation which leads to Private Sector Jobs? Would that be the specter of much higher Federal and State personal and business taxes? Tax and Trade (energy tax)? Socialized Medicine (tax)? Over Regulation (reduce profits at the margin)?

The Stimulus Plan either needs completely recalled, or if that is too much egg-on-the-face for the powers-that-be, then recall, redesign, redeploy.

Rick said...

The 2Q GDP preliminary GDP report showed that the biggest cause of increased federal spending came from defense spending that was finally appropriated - not from non-defense federal government spending from the Obama stimulus plan. Of that $787 billion appropriation about $725 billion is still sitting as ink on paper that comprises the budget plans of most federal agencies.

__ said...

There's an excellent two part series called "Fiscal Follies" that was published RBS in April. I recommend it reading it if you have access to their research.

Mark A. Sadowski said...

There is considerable reason to believe the liquidity trap will last not only into next year but into 2011 and 2012 and beyond. Here is what Glenn Rudebusch of the FRBSF had to say in May:

"The estimated Taylor rule can also be used in conjunction with economic forecasts to provide a rough benchmark for calibrating the appropriate stance of monetary policy going forward. The dashed lines in Figure 1 show the latest forecasts for unemployment and inflation provided by FOMC participants—the Federal Reserve presidents and governors. (The dashed lines are quarterly linear interpolations of the median forecasts in FOMC, 2009.) Like many private forecasters, FOMC participants foresee persistently high unemployment and low inflation as the most likely outcome over the next few years. The recommended future policy setting of the funds rate based on the estimated historical policy rule and these economic forecasts is given as the dashed line in Figure 2. This dashed line shows that, in order to deliver a degree of future monetary stimulus that is consistent with its past behavior, the FOMC would have to reduce the funds rate to -5% by the end of this year—well below its lower bound of zero. Alternative specifications of empirical Taylor rules, described in Rudebusch (2006), also generally recommend a negative funds rate.

The shaded area in Figure 2 is the difference between the current zero-constrained level of the funds rate and the level recommended by the policy rule. It represents a monetary policy funds rate shortfall, that is, the desired amount of monetary policy stimulus from a lower funds rate that is unavailable because nominal interest rates can't go below zero. This policy shortfall is sizable. Indeed, the Fed has been able to ease the funds rate only about half as much as the policy rule recommends. It is also persistent. According to the historical policy rule and FOMC economic forecasts, the funds rate should be near its zero lower bound not just for the next six or nine months, but for several years. The policy shortfall persists even though the economy is expected to start to grow later this year. Given the severe depth of the current recession, it will require several years of strong economic growth before most of the slack in the economy is eliminated and the recommended funds rate turns positive."

The Excel file containing the relevant data can be found here:

These calculations are based on FOMC economic projections through the end of 2011 and show that according to the Taylor Rule the federal funds rate will be against the zero lower bound through then. Simply extending the FOMC economic projection trends suggests that this will persist throughout 2012 as well. But note that the FOMC economic projections were a little optimistic. They forecast a peak unemployment rate of 9.45% in the fourth quarter and we have already surpassed that rate as of June.

Thus based on the FRBSF's own projections of the federal funds rate according to the Taylor Rule virtually all of this stimulus will be spent before we exit the liquidity trap. Consequently this stimulus is not only necessary and will be effective, still more may be called for.

And so that is why the list of distinguished economists favoring more fiscal stimulus continues to grow:

Scott Grannis said...

One of us is going to eat a lot of crow.

Mark A. Sadowski said...

Or see the light.

W.E. Heasley said...

Sadowski vs. Grannis

Sadowski is very likely wrong. Grannis is very likely right. I’d take the In-Trade on Grannis. Why?

(1) the Taylor Rule was violated by the Fed which created a bubble in the first place (Getting Off Track by none other than John Taylor),

(2) now the Fed is quoting the Taylor Rule (convenient huh?),

(3) QE and Keynesian Government Deficit Spending are theories developed in low or zero existing Government Debt. Simultaneous deploying QE and Keynesian Government Deficit Spending in an environment of current high debt, debt increasing at an increasing rate, is uncharted waters with basically only one real-economy result to draw upon : Japan 2001-2006. The Japan result was/is dismal,

(4) if simultaneously deploying QE and Keynesian Deficit Spending, in a high debt environment, the “size matters argument” of the stimulus is certainly trumped by the “design matters argument”,

(4a) the first stimulus was large in size but poor in design. At the end of the day, the current stimulus was based on Political-Political not Political-Economy. The current stimulus plan was not based on the historical Keynesian Design of Infrastructure Spending rather it was based on Social Engineering,

(4d) the current design of the current Stimulus plan is not an employment generator, the design is a transfer payment generator,

(5) the call for a second stimulus plan is of the “size matters” argument. The first and proposed second stimulus are/would be 100% financed. That means the environment of current high debt is being magnified by the financed stimulus plan(s). The debt creates major economic drag,

(5a) financed stimulus plans create economic drag, creating a smaller stimulus with better design creates more stimulus at a lower economic drag cost,

(6) exiting QE is dicey. Removing QE is an unknown/unknown. Exactly what Open Market Operation Committee or Central Bank has ever faced this size and dynamic of QE removal (?),

(6a) since the original Stimulus was based on Political-Political, what makes one think that when withdrawing QE that political hacks will not get in the way? That the best intentioned withdrawal of QE will get mucked up by Politicians.

The specter of the large current Government Debt does affect the Macro World. The current Stimulus plan creates the specter of higher taxes which would depress Private Capital Formation and activate all the associated consequences. Recalling the Stimulus, redesigning the stimulus, redeploying a smaller well designed stimulus would be a positive sign to markets and general expectations given the economy is attempting to rebound on its own.

As a side note: when a Political Figure actually attempts to bring up a “recall” of the Stimulus Plan, the recall is met with Thug-o-nomics from the White House. See links below: