“Too big to prosecute” is the recurring headline this week after Attorney General Eric Holder’s remarkable statement before the Senate Judiciary Committee on Wednesday:
“I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy.”
Where to begin? “Too big to fail” is one thing, but to say these institutions are too big to clean up their act is another. The attorney general seems to be implying that the big banks are more important than the laws themselves. It is one thing to say that the outright collapse of these institutions would bring economic ruin. It is quite another to assume that prosecuting criminal acts by them or some of their employees would also bring ruin.
Skeptics have long called the big banks “too big to prosecute” because their lavish campaign contributions give them unparalleled access and influence in Washington, but Holder’s remarks point to something more insidious: ideological capture. When cabinet officials are products of Wall Street or, worse, credulously believe Wall Street claims that their firms are delicate life-giving flowers that must never be disturbed, we have a problem that won’t go away anytime soon.
Fortunately, several members of Congress, including Republicans David Vitter and Charles Grassley and Democrats Sherrod Brown and Elizabeth Warren, are pushing back. Vitter and Brown have co-sponsored a bill to limit the size of the big banks. But we have been here before, as recently as 2010, when a similar bill lost by a vote of 61-33 and was opposed by the Obama administration. Until further notice, it’s hard to disagree with these words of Huey Long from 1932:
“They’ve got a set of Republican waiters on one side and a set of Democratic waiters on the other side, but no matter which set of waiters brings you the dish, the legislative grub is all prepared in the same Wall Street kitchen.”
My views on the $85 billion meat cleaver of federal spending cuts, also known as the “sequester,” are entirely predictable to anyone who knows me or has been reading this blog. I think it’s a dumb thing to do when the economy is still weak and needs more deficit spending rather than less, it’s bad public policy to make indiscriminate cuts instead of selective cuts, and it’s not surprising that Congressional Republicans chose sequester over a balanced package of spending cuts and tax increases. I didn’t blog about it earlier because I didn’t want to be too predictable.
What’s interesting to me is that the sequester is nothing new in a sense. We had the opposite policy for two years, in the form of the 2009-2010 stimulus package, which pumped about $394 billion per year in new federal spending into the economy, and then the federal stimulus went down to about $0. The original yearly amount was about 2.5% of GDP, which should have boosted the economy quite a bit. Many leading estimates are that it did. The Commerce Department’s Bureau of Economic Analysis breaks down the contribution to GDP growth of the different components (household consumption, business investment, government purchases, net exports). Their estimates are that the federal government’s contribution to economic growth was just 0.74 percentage points in 2009 and a minuscule 0.14 points in 2010. (In both years, consumption and investment accounted for most of the change in GDP.) Possibly those numbers are underestimates and they probably do not account for any “multiplier” effects on consumption (people get money from the government and go out and spend it, etc.), but what I want to focus on is the next year, 2011, when the stimulus basically ran out.
In 2011, the combined federal, state, and local government contribution to real GDP growth was -0.67 points (which looks kind of small to me considering that stimulus spending fell by about $300 to $400 billion). It wasn’t much better — -0.34 points — in 2012. A problem with fiscal stimulus is that it’s temporary — if the patient doesn’t respond immediately, Dr. Congress decides that the medicine doesn’t work or is too expensive.
The sequestration amount for 2013 is $85 billion, or roughly 0.5% of GDP. Economists’ estimates of the size of the multiplier vary, from below 1 to about 1.4, so the likely reduction in GDP would be in the range of 0.3% to 0.7%. This would definitely hurt, but keep in mind that the government was tightening its fiscal policy in 2011 and 2012, too, with negative impacts of about the same size. To further play devil’s advocate, while the sequester is bad news and bad public policy, it’s unlikely to push the economy into recession, not if consumption and investment continue to grow as fast as they did over the past three years (with an average combined contribution to growth of about 2.5 percentage points). It’s still a lousy time to cut spending and raise taxes, but in the aggregate these cuts are mild enough that they’re merely misguided, not catastrophic.
So much for our supposed big-government Keynesian president: government jobs, the emblem of New Deal anti-depression policy, have actually gotten more and more scarce since President Obama took office. Since the recovery began in June 2009, the number of public-sector jobs has shrunk by almost 3%.
Most of that reduction has been at the state and local level, but it’s striking that the decline has been fairly continuous despite the $787 billion two-year federal stimulus package in 2009-2011. As I’ve noted before, the stimulus bill took pains to ensure that nearly all of that temporary job creation would be for private contractors. And as I’ve lamented before, it’s rather hard to have effective fiscal policies when our current politics demonizes direct government job creation (i.e., giving people government jobs) as worse than doing nothing. This is all the more remarkable considering that direct job creation was the calling card of the most popular president of the last century, Franklin D. Roosevelt, whose New Deal programs created an average of three million government jobs per year in 1933-1940. One could even argue that the political success of those programs was a big part of the reason why conservatives oppose them so fiercely, at least whenever they’re contemplated by Democrats.
What’s also striking is that this pattern is in contrast to all three of the previous recessions (1981, 1990, 2001), when public-sector employment actually grew. Notably, all three of those past recessions were under Republican presidents — maybe it’s a “Nixon goes to China” phenomenon, where only conservative-seeming Republicans can get away with increasing government employment. (Then again, it’s possible that most of the action was at the state and local level, though I’d suspect that the 1980s military buildup accounted for much of the increase under President Reagan.) Most striking of all is that the ultimate Keynesian here was Ronald Reagan, who oversaw an increase of almost 4% in government jobs in the first 30 months of recovery, the most of any of these presidents. Graph from Josh Bivens of the Economic Policy Institute (hat tip: Andrew Sullivan):
The Republican “starve the beast” strategy of running up huge deficits (preferably by cutting taxes on the wealthy and raining money on military contractors) and then using them as an excuse to cut social programs is nothing new, but this interview tidbit with iconic conservative economist Friedrich von Hayek was new to me:
‘A 1985 interview with von Hayek in the March 25, 1985 issue of Profil 13, the Austrian journal, was just as revealing. Von Hayek sat for the interview while wearing a set of cuff links Reagan had presented him as a gift. “I really believe Reagan is fundamentally a decent and honest man,” von Hayek told his interviewer. “His politics? When the government of the United States borrows a large part of the savings of the world, the consequence is that capital must become scarce and expensive in the whole world. That’s a problem.” And in reference to [David] Stockman, von Hayek said: “You see, one of Reagan’s advisers told me why the president has permitted that to happen, which makes the matter partly excusable: Reagan thinks it is impossible to persuade Congress that expenditures must be reduced unless one creates deficits so large that absolutely everyone becomes convinced that no more money can be spent.” Thus, he went on, it was up to Reagan to “persuade Congress of the necessity of spending reductions by means of an immense deficit. Unfortunately, he has not succeeded!!!”’
The snippet comes from this article about David Stockman, former Republican Congressman and Reagan Office of Management and Budget Director. Another keeper:
‘The deficits were intentional all along. They were designed to “starve the beast,” meaning intentionally cut revenue as a way of pressuring Congress to cut the New Deal programs Reagan wanted to demolish. “The plan,” Stockman told Sen. Daniel Patrick Moynihan at the time, ” was to have a strategic deficit that would give you an argument for cutting back the programs that weren’t desired. It got out of hand.”’
All of which is worth remembering the next time you’re subjected to the hand-wringing of yet another media or political figure who says the deficit is our biggest problem. (Usually these people don’t bother to mention the 25 million unemployed and underemployed, or the $1 trillion output gap.) Yes, the deficit is a problem, but don’t forget where it came from, and especially don’t trust anyone who says reversing the 2001 tax cuts or cutting military spending can’t be part of the solution.
The so-called “supercommittee” of six Democrats and six Republicans, charged last summer with drafting a deal for $1.2 trillion in spending cuts over ten years, failed to do so by today’s deadline. The so-called teeth in last summer’s agreement to form a supercommittee was that Congress would either accept their proposal or submit to $1.2 trillion in automatic, across-the-board spending cuts. Is this good news, bad news, or irrelevant?
Good, says Paul Krugman. To be precise, he said that last week. His reasoning was that cutting spending is counterproductive in a time of economic depression, as it will just exacerbate the depression, so it’s best that they didn’t make a deal to cut spending. Today, he’s a bit more nuanced, noting a Bloomberg.com story about how the supercommittee’s failure is rattling markets but highlighting this aspect of the story (Krugman’s words):
‘. . . what it actually says is that market players fear that the absence of a debt deal means no stimulus. So the actual fear is not that spending won’t be cut enough, it is that it will be cut too much — which actually makes sense, and is consistent with the action in stock and bond markets.
‘But how many readers will get that? The way it’s presented reinforces the false notion that the deficit is the problem.’
Bad, says Kevin Drum. At least if you’re someone like Kevin Drum, Paul Krugman, or me, who thinks it’s foolish to cut social spending in a depression and really isn’t all that keen on slashing the social safety net in general. Unlike Krugman, Drum thinks many if not most of the automatic spending cuts will go into effect. The deal is only good if you’re a Republican who lives to cut social programs. In other words, the Democrats got rolled again, just as in the bogus “debt ceiling authorization” debate. Drum:
‘In any case, this should basically be viewed as a total victory for Republicans. Any alternative plan would have included some tax increases, so failure to come up with an alternative means that we get a big deficit reduction that’s 100% spending cuts, just like they wanted. And the 50-50 split between domestic and defense cuts was always sort of a joke. Republicans never had any intention of allowing the Pentagon’s half of the cuts to materialize, and the domestic spending half of the cuts was about as big as they wanted them to be. Big talk aside, they know bigger cuts would run the risk of seriously pissing off voters.
‘So Republicans got domestic spending cuts that were about as big as they really wanted. They know they’ll never have to implement most of the defense cuts. And there are no tax increases.’
Irrelevant, say the bond markets. The demand for ten-year U.S. Treasury bonds was actually up slightly today, whereas really bad news about the long-term U.S. fiscal position should send demand down and interest rates up. Either the market regards $1.2 trillion over 10 years as no big deal (and it is rather small compared with a national debt of $14 trillion), or they were expecting the supercommittee to fail all along. Or both.
This just in: The Federal Reserve does not control the universe.
Stated differently: The economy is in a liquidity trap (macroeconomists). Or, monetary policy has shot its wad (Pres. Obama to economic adviser Christina Romer in their first meeting, according to Ron Suskind’s Confidence Men). Krugman has been saying this for three years now, and so have a lot of other economists. But until today, I had yet to hear it from a Fed official. Fed Chairman Ben Bernanke has called for Congress to pursue a more expansionary policy fiscal policy, thus implying but not explicitly saying that the Fed has done just about all it can. But in a speech today, Chicago Fed President and Federal Open Market Committee member Charles Evans had the guts to state the obvious:
“I largely agree with economists such as Paul Krugman, Mike Woodford and others who see the economy as being in a liquidity trap: Short-term nominal interest rates are stuck near zero, even while desired saving still exceeds desired investment. This situation is the natural result of the abundance of caution exercised by many households and businesses that still worry that they have inadequate buffers of assets to cushion against unexpected shocks. Such caution holds back spending below the levels of our productive capacity. For example, I regularly hear from business contacts that they do not want to risk hiring new workers until they actually see an uptick in demand for their products. Most businesses do not appear to be cutting back further at the moment, but they would rather sit on cash than take the risk of further expansion.”
Evans went on to suggest a number of measures the Fed should still take, like buying up more mortgage-backed securities to get the housing market going (I’m still on the fence on that one — yes, this is the economy’s weakest sector, but how do you do this without reinflating the housing bubble?), while keeping mum on the subject of whether this would do anything more than just nudge the economy forward, as opposed to bringing us anywhere near full employment. I suppose the question is moot, as long as nobody else is willing to act. Congress is not only unwilling to consider fiscal stimulus but seems to be on the verge of massive budget cuts, either by following the “super committee’s” blueprint or letting an autopilot crash the plane.
“Italy Is Now the Biggest Story in the World,” says Kevin Drum. And he’s not talking about Joe Paterno (whose story I confess to having spent a lot more time following lately than Italy’s). But this is bad: another Eurozone country with a high debt/GDP ratio, soaring interest rates on its government debt, and no currency of its own that could depreciate to revive net exports, and no central bank of its own to expand the supply of credit. Just like Greece, except that Italy’s economy is about six times as large. It’s the fourth-largest economy in all of Europe, in fact.
For months people have been nervously watching Europe’s toxic cauldron of economic depression, austerity, sovereign debt crises, and bank funding problems (verging on crisis), and wondering if and when Europe’s problems might lead to a double-dip recession (or, as I’d call it, a recession within a depression, a la 1937). I wonder if someone else has already written the headline “Italy: Waiting for the Other Boot to Drop” yet.
P.S. If you’ve never heard the expression “Mingya!” then you obviously don’t live in Oswego. The Urban Dictionary will set you straight.
Kansas City Federal Reserve Bank President Thomas Hoenig was my favorite recent member of the Federal Open Market Committee, mainly for his outspoken and eloquent criticism of the “too big to fail” policy. I’ve written about his ideas a few times, including here. So now that the Kansas City Fed’s rotating term on the FOMC has come to an end, it’s good to see that President Obama has nominated Hoenig to be Vice Chairman of the Board of Directors of the Federal Deposit Insurance Corporation (FDIC).
Hoenig’s views are summed up in this quote from the article: “We must make sure that large financial organizations are not in position to hold the U.S. economy hostage. We must break up the largest banks.” His March 2009 speech “Too Big Has Failed” lays it out in detail.
Now, I have no idea how much policy-shaping ability the vice chairman of the board of directors of the FDIC has, and Hoenig himself has said the FDIC still lacks adequate resolution-authority powers for closing big bank holding companies, but I’ll be glad to have him back in the loop. Assuming that Senate Republicans don’t block his nomination for one reason or another.
I think this is the first time I’ve ever agreed with Grover Norquist on anything: Herman Cain’s tax plan is bogus. Naturally, old Grover and I have different reasons for thinking it so. He says that having three 9% tax rates — income, profits, and sales — is “like having three needles in your arm.” There’s also the conservative objection that a sales tax is just too easy a way to raise revenue, making it harder for Norquist to realize his dream of starving the government beast and drowning it in the bathtub.
Unlike Norquist and Cain, I’m one of those people who’s against regressive taxes, like, you know, a 9% sales tax. As David Weigel at Slate noted, it seems to be about sticking it to that alleged freeloading 47% who don’t pay income taxes (but do pay payroll, excise, and state income taxes). And, as Bruce Bartlett notes, there’s no mention in Cain’s income tax plan of a personal exemption, so the income tax rate is presumably 9% for everyone. So Cain would raise taxes on nearly half the population by up to 18% of their income.
Once upon a time Republicans boasted about taking poor people off the income tax rolls (as with the Reagan tax reform of 1986 and even the Bush tax cuts of 2001), but times have changed. Demanding that almost half of Americans pay an extra 9% of their income in taxes is now the order of the day, as long as that half is the poorer half.
Oh, and if lowering the top income tax rates to 9% weren’t enough Robin Hood in reverse, Cain’s plan would also exempt capital gains from taxes altogether. Imagine, hedge fund managers might not have to pay income taxes at all!
And then there’s the issue of lost revenue from slashing tax rates and shrinking the tax base for the affluent. The basic rationale for progressive taxation is that it raises more revenue more easily than flat or regressive taxation. Cain claims that his upper-income tax cuts would spur so much prosperity that they’d pay for themselves. Stop me if you’ve heard that one before.
. . . is how I’d describe this month’s major developments on the fiscal and monetary policy front, namely Pres. Obama’s new jobs proposal and the Fed’s decision to reallocate its Treasury bond portfolio so as to try to push long-term interest rates down.
The Fed’s decision is simpler, so I’ll start with that one. Last Wednesday the Federal Open Market Committee kept its fed funds rate target unchanged at 0-0.25% and announced that it would sell most of its short-term T-bill portfolio and replace it with longer-term T-notes and T-bonds. This is quite a bit less than the “QE3” (quantitative easing, round 3) that many in the market were hoping for, as it does not involve a net increase in the Fed’s Treasury holdings, and the stock markets took a tumble that afternoon. The media quickly dubbed the Fed’s move “Operation Twist,” after a similar action in 1961. Nobody expects this move to have more than a marginal impact, not when mortgage and other long-term interest rates are already at historic lows, but it’s hard to argue against a positive marginal impact, purchased at so little cost. A Wall Street Journal editorial notes that the 1960s Operation Twist lowered long-term interest rates by about 0.20 percentage points, and “Some experts said that was enough to make the program effective; others deemed it a failure.” It seems to me that any reduction in unemployment from this move, however small, is welcome news at a time of 14 million unemployed.
The President’s new jobs bill is a more complicated animal. (Note that they’ve dropped the term “stimulus package,” apparently out of belated recognition that “jobs bill” is simpler and sounds more appealing and also because the $787 billion stimulus of 2009 is unpopular. I’ve been over this one before: leading estimates are that it saved a few million jobs, which is good, but it was supposed to save all of them, and that obviously didn’t happen. Thus it is unpopular.) The main complication is that it has no chance whatsoever of passing, given knee-jerk opposition to all things Obama in the Republican-controlled House and the Republican-filibuster-strength minority in the Senate. This despite the fact that, as Obama said, that virtually everything in it has been supported by Democrats and Republicans alike. (To be fair, not much in it has been supported by Republicans recently, i.e., since Obama became president.)
Specifics: The American Jobs Act (its official name) has a price tag of $447 billion, most of which apparently would be spent during the next 12 months, so roughly the same yearly amount as the 2009 stimulus. More than half of that is a $240 billion cut in payroll taxes, including a reduction in the payroll tax paid by workers, a cut in the employer share for small businesses, and a tax holiday for new employees. The next biggest item is $140 billion for infrastructure and local aid, notably transportation, retaining and rehiring teachers and first responders, and modernizing public schools. The last area is $62 billion for unemployment insurance extensions, tax credits for hiring the long-term unemployed, and subsidized employment for low-income individuals.
All of this seems reasonable, maybe too reasonable. In a less toxic political environment, this proposal would pass, but just like the 2009 stimulus, it would be way too small to fill America’s jobs deficit. The payroll tax has already been cut to 4.2% (down from about 6.2%), and the jobs bill would cut it to 3.1%, or about $11 on every $1000 of income. Small potatoes. And while poorer workers would surely spend their payroll tax cut, upper-middle class and upper-class workers would probably save much of theirs. The current payroll tax cut is set to expire at the end of this year, and Republicans aren’t crazy about it (they prefer permanent tax cuts aimed at “job creators” in the top tax brackets) but don’t want to be cast by Democrats as favoring tax increases for the little guy, so a further extension of the 4.2% payroll tax rate seems likely.
The payroll tax holiday and ($4000) tax credit for hiring the unemployed should also be expected to have a positive but marginal impact on employment. The number one question in any prospective employer’s mind is “Can I sell the extra output that this person would produce?” Tax holidays and tax credits make a Yes more likely, but only if the product demand is strong enough to almost warrant hiring the person in the first place. Still, we economists live at the margin, and as with the Fed’s Operation Twist, anything that creates jobs at minimal cost is a positive thing.
And now on to costs. This is the main area where I have a problem with the president’s proposal. Obama says the program is fully funded, when really that’s the last thing we should be worrying about during a depression.The more you offset the new spending and tax cuts with spending cuts and tax increases elsewhere, the less stimulus you have. Obama said the program will be paid for by additional spending cuts in the future, closing corporate tax loopholes, and reinstating the “millionaire’s tax” on personal income. (Note: We last had a $1 million tax bracket in 1940, in nominal terms. Adjusting for inflation, we last had a $1 million tax bracket in 1973.) If the spending cuts are sufficiently far off in the future, like when the unemployment rate is back below 6%, they should do little macroeconomic damage. Ditto the closing of tax loopholes — which probably have little to do with hiring anyway — and the millionaire’s tax. As far as I can tell, those tax increases — and some others that I would support, like taxing hedge fund managers’ salaries as ordinary labor income instead of at the lower capital gains rate — would take effect immediately. While I don’t buy the Republican rhetoric about every rich person being a Job Creator, I still don’t think raising taxes in a depression is a good idea. It can wait.
Blogging Through the Wreckage 