Thursday, December 18, 2008

The Macroeconomy

This was going to be a series, but I've lost some of my ambition. I've tried to present these in order of increasing fuzziness, I make no claims of expertise in anything except the optimal planting/trading/etc of coconuts. Business cycles are next term.

1. Fiscal stimulus.
I am a skeptic. I believe the one-year multiplier is about one. Four years forward, insignificant from zero. There are sufficently many studies out there to justify any numbers out there that you want to believe, but people that believe that any large amount of stimulus can be 2 or greater I classify as pie-in-the-skiers. At that point, you're getting to the exact opposite of the far end of the Laffer curve - the tax revenue generated by fiscal stimulus is sufficient to pay for the fiscal stimulus. Given that even Krugman has yet to make this argument, I suspect we're all in agreement that it's not that high - and yet that's what the mathematics and marginal tax rates imply.

Secondly, I have yet to hear a convincing explanation for two things. One, if as Krugman says, we're turning Japanese, why did the history of Japanese fiscal stimulus (and bailouts of financial institutions?) fail so miserably? The one thing we've done differently from the Japanese is that we've been more aggressive monetarily, but nobody seems to think that monetary policy is worth squat anymore; they may well be right. The other recent participant in massive rounds of fiscal stimulus - Germany sending money from West to East - has declined to participate in fiscal stimulus in recent weeks. Both of these endeavours were substantially larger than even the trillion that's been bandied around as the cost of Obama's plan, and have only left a bad taste in mouths. Why is it different on this continent right now? I can't see why it would be.

Third, government is the wrong engine to implement stimulus. Government works on a scale of months; markets move on a scale of hours or even minutes. There is a fundamental problem here.

2. Deflation
I am also not sure why we're so scared of deflation. One of the arguments I've heard is that deflation will result people in hoarding cash, waiting for prices to fall. I find this particularly hard to believe. There are tens of millions of people in the United States who have no problem financing purchases on credit cards and paying the associated interest charges month after month after month at rates that are much, much higher than any realistic degree of deflation. I find it difficult to believe that people will substantially adjust their behaviour if the economy moves from 2% inflation to 2% deflation. Computers have deflated more quickly than anything else on the planet over the last decades, but people hardly waited to buy them. I admit the argument for firms is somewhat more compelling.

3. Irrationality of asset markets.
A lot of people look at the headline DJIA number to form their opinion on the state of the economy. Notwithstanding just how archaic the methodology behind this index is, or how small a snapshot of the economy that number is, I can't figure out how the markets can move so much. Neither can anyone else, really. See the Worthwhile Canadian Initiative for details. Given that one of the main goals (the main goal) of policy efforts designed to get things moving is to raise stock values, I think I'm safe in being skeptical of efforts to raise stock prices when we don't have a sweet clue how they're formed. This also extends to recessions in general, albeit less so.

4. Expectations.
Each time we have a recession, I think there's an ingrained belief that we have to go at least as far as we did last time. Fighting off an equally sized demand shock will take more work each time we have to do it. If this is at all true, it spells big trouble - especially next time. In general, this is an argument for more laissez-faire with respect to stabilization policy. Just like traders are confident that they're better than most everyone else in the marketplace, so too are economists overconfident in their prescriptions. This has a partial tie in with moral hazard, which has been discussed to death, only reaching the consensus that there is no consensus on how big a deal it is.

5. Does anyone really believe that even if GDP growth gets back to trend and house prices start going up again, that people will want to buy all these assets at anywhere near their prior prices?

1 comment:

Simon said...

Can you elaborate on your first three sentences of #1?