Policy in the pub – Melbourne – August 19 @ 5:30 pm

krugman and me july 2015

I will be debating Alan Oster, the Chief Economist of the National Bank, on “Stimulus versus Austerity” on August 19 at the Imperial Hotel in Melbourne on the corner of Spring and Bourke @ 5:30 pm. If you are interested in coming along, please email Joe Dimasi to let him know: [email protected]

Although normally I like to go first in such things, on this occasion I have asked to go second since I can no longer even imagine what a yes case for the stimulus could be. It is for that reason primarily I will be coming along on the night. In the meantime, these are the notes I am putting together as I prepare. I should also mention that neither of the two in the picture above is Alan Oster.

Using the term “Austerity” as the noun meaning sound finance and fiscal prudence already tips the debate, both here and internationally, in a negative direction

Back in the 1990s, before their ill-fated stimulus, I sat next to the Japanese Finance Minister at a lunch where I told him not to do it. His reply – “Don’t you care about the unemployed?”

Keynesian economics is a cult – believed in spite of the fact that it makes no economic sense and has never actually worked in practice

The GFC was not, obviously not, caused by a failure of demand. It was not caused by too much saving. In America, it was the product of a crash in the housing industry that fed into its financial system. In the rest of the world, the problem was entirely financial, with credit frozen across the globe.

The answer was the TARP which unfroze credit which I think was the right thing to do [but is not part of this debate]. The subsequent stimulus was not only unnecessary, but positively harmful [which is part of this debate].

See my Quadrant article from February 2009: The Dangerous Return to Keynesian Economics.

I also wrote my Free Market Economics, now in its second edition, to explain why the hysteria surrounding the GFC was misplaced and the stimulus would be a disaster

The notion of a “stimulus” is, of course, Keynesian. Economic theory always accepted a role for public spending as a palliative. No one thought of spending as a cure.

The idea of a stimulus is based on the belief that economies enter recession because there is too much saving. The government must therefore enter the picture and put those savings to use if the economy is not to enter a long drawn out recession and unemployment is to come down in a reasonable period of time.

The belief is that government must put those savings to work asap, even if the form in which the spending takes place is not in itself value adding. Even if the initial spending is not value adding, the multiplier will do the work of ensuring that the rest of the expenditure is properly based on profit-making activities.

The basis: Y=C+I+G. If C and I fall, G is raised to replace the missing expenditure.

C, I and G are final demand. The rest of the economy, the hinterland behind final demand, is ignored. It will simply structure itself to conform to whatever is being bought at the end of the production trail. Eventually everyone will be employed if there is enough spending on final goods and services. It hasn’t worked out that way, but then again, I never thought it would.

Suppose we heard that entrepreneurially-driven construction activity with no government subsidy was to double over the next ten years, would we not all agree that the economy would be bigger and stronger at the end of that time, more jobs would be created and real incomes would rise. Suppose, instead, we heard that over the next ten years there would be twice as many meetings of the Economic Society and the number of journal articles would double. What then would be the effect on output and employment, do you think?

Record 93,770,000 Americans Not in Labor Force…
Participation Rate 38-Year Low…
Record 56,209,000 Women Not Working…

For a more detailed understanding of why the stimulus was madness, now demonstrated in the deeply recessed economies across the world, see the Liberty Fund discussion on John Stuart Mill for which I wrote the lead article.

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40 Responses to Policy in the pub – Melbourne – August 19 @ 5:30 pm

  1. Kool Aid Kid

    Yet again Steve: you fail to differentiate arse from elbow. It was fake financing that inflated and then blew up the US housing market. Not the other way. And it is an excess of financial influence inthe Australian economy – all driven by public policy interventions – that crafts our next problems.

  2. blogstrop

    It was political leftism that blew up the US housing market, by activism morphing into rules for banks about redlining, and then in effect making it too hard for them to not lend to bad prospects . Then add a nationalised mortgage lender (or two) with no handbrake.

    Stimulus spending is as successful as socialism. The US housing market became an exercise in socialism genetically spliced to a form of stimulus spending. It was doomed from the point where banks were told not to refuse loans simply because the applicant had insufficient funds or income.

  3. Tel

    Using the term “Austerity” as the noun meaning sound finance and fiscal prudence already tips the debate, both here and internationally, in a negative direction.

    You mean government finance, I presume, not finance in general. Individuals are normally free to lend money to each other based on their own personal judgement so unless there’s good reason to repress them, the private sector would be outside the realm of policy, right?

  4. Tel

    . It was fake financing that inflated and then blew up the US housing market.

    Fake finance, sounds serious. The money was not real you say?!?

  5. Andrew

    Good to see the TARP mention – there are people here so irrational that they actually oppose the financial, as opposed to Keynesian, policy responses.

  6. Driftforge

    unless there’s good reason to repress them, the private sector would be outside the realm of policy, right?

    No. You cannot ignore private debt in policy or economics.

  7. dangermouse

    Steve, you tower over Krugman in more ways than one.

  8. Yohan

    Is that Steve and Krugman sitting together? When did that happen !

  9. Kool Aid Kid

    Tel: no. It was real money. Mostly taxpayers money in the end. Because fake credit proofs inflated fake wholesale finance which inflated fake valuations and then credit standards went to shit.
    It truly amazes me that supposed conservative are inured to radical finance, which is rampant.

  10. JC

    Good to see the TARP mention – there are people here so irrational that they actually oppose the financial, as opposed to Keynesian, policy responses.

    What was rational about TARP?

  11. .

    Good to see the TARP mention – there are people here so irrational that they actually oppose the financial, as opposed to Keynesian, policy responses.

    It was utterly idiotic.

  12. Hugh

    If we pan out, is Robert P Murphy on that guy’s left?

  13. Rob MW

    “Tel: no. It was real money. Mostly taxpayers money in the end. Because fake credit proofs inflated fake wholesale finance which inflated fake valuations and then credit standards went to shit. It truly amazes me that supposed conservative are inured to radical finance, which is rampant.”

    So the point of difference with Steve’s point is fucking what ?

    Did Fannie Mae wipe your arse with Freddie Mac sandpaper whilst engaging in oral sex with a community organiser mate ?

  14. JC

    Former Well Fargo CEO discusses the fascist TARP reckons it made the GFC worse.

  15. Oh come on

    If TARP didn’t make the GFC worse, Krugman’s tie undoubtedly did. Egads.

  16. Ray

    “The idea of a stimulus is based on the belief that economies enter recession because there is too much saving.”

    Keynes’ notion of a savings glut was based upon a diminishing marginal efficiency of capital. In other words, as savings grow, demand falls thus reducing returns to capital and so producing a savings glut because there are a shortage of viable investment opportunities. This is the crucial failure of Keynesianism. If investment opportunities do not diminish, then savings are recycled into the economy through investment, generating increased production and so growth.

    I can agree with Keynes that investment opportunities did evaporate during the Depression and also briefly (i.e. for a few months) during the GFC but only because of a melt down in the payments system. However, the steady march of innovation throughout the economy is testimony to the fact that such savings gluts are only temporary.

    Of course, Keynes himself recognized this and viewed demand management as a very limited tool, aimed solely at infrastructure spending, not the recurrent expenditure which is the crux of the stimulus packages which are pursued in his name today. In fact, Keynes would turn in his grave for he was diametrically opposed to giving politicians the ammunition to waste taxpayers money on welfare programs. In this regard, Keynes has been fundamentally misunderstood by those who have followed him.

    Therefore, Keynes misunderstood the dynamic nature of capitalism. He underestimated the ability of capital to pursue innovation and risk and consequently overestimated the capacity of governments to manage demand. In this regard, his policy prescriptions were flawed.

  17. Tel

    Tel: no. It was real money. Mostly taxpayers money in the end. Because fake credit proofs inflated fake wholesale finance which inflated fake valuations and then credit standards went to shit.

    Government National Mortgage Association (GNMA) or “Ginnie Mae” designed by President Franklin D. Roosevelt to provide both taxpayer backing to mortgages, and also provide one national standard (the so called “Prime” loans) for all mortgage credit evaluation… both of which were lies, the effect being to systematically destroy the ability for the market to calculate risk.

    The first lie is that the taxpayer has the ability to operate as backer for the entire mortgage market. Since tax always get increased to the limit of the ability to pay (i.e. government will optimize against the Laffer curve) should there be a widespread event whereby prices dip across the board, GNMA has no real ability to draw massive additional funds to prop this up. Government simply cannot extract this amount from the taxpayer, because the taxpayer doesn’t have it. At any rate, it’s worse because in many cases the taxpayers themselves are the same people being guaranteed by themselves. Same for government deposit guarantees of banks by the way… it’s not real, only the illusion of security.

    The second lie is that a centrally planned standard for credit evaluation works better than a decentralized system with many independent evaluations. Any centrally planned system is fragile to a change in environment that will result in highly correlated failure. You get an Irish Potatoe Famine on your hands.

    It truly amazes me that supposed conservative are inured to radical finance, which is rampant.

    If I lend my mate $50 till the end of the week, what business is that of yours? If the taxpayer gets behind it and guarantees repayment… well, there’s your problem.

  18. Sydney Boy

    I don’t think you can lump all the stimulus of the RGR government into one bucket. There are differing economic effects between handing out $900 cheques to dead people, paying uneducated shysters to burn down houses, and upgrading school facilities (which unfortunately included buying expensive lattes to men in suits).

  19. .

    There are differing economic effects between handing out $900 cheques to dead people

    That was the least destructive.

  20. Sydney Boy

    I don’t think so Dot. $13B of taxpayer cash paid to everyone who didn’t pay tax versus $15B in infrastructure for schools? (Ignore how badly managed the school cash was). It was just the opportunity for another socialist cash redistribution effort.

  21. Kool Aid Kid

    Tel: ask yourself this: what has the AIG bailout got to do with mortgage guarantees? The answer is nought. They would have written those CDO swaps regardless. And that is the problem that has not gone away.
    RobMW: grow up.

  22. .

    Ignore how badly managed the school cash was

    I’m afraid I can’t let you do that.

  23. Sydney Boy

    I’m afraid I can’t let you do that.

    OK. Fair enough. But as a concept and intention, it was OK. Just managed very badly.

    Q. What is the difference between the Boy Scouts and the government?

    A. The boy scouts have adult supervision.

  24. .

    Giving people money out of unfunded only has the cost of future tax collection (inflation, lower growth).

    Vandalism is worse than theft.

    Spending money poorly on projects which require remediation have both of those costs on top of future tax collection.

    The only additional cost to the doling out of cash is that it may be spent in a temporary, not permanent manner. However most was banked and it was an accidental recapitalisation of our banks (which is why the Keynesian theory could not even work, on top of external leakages).

  25. .

    Tel: ask yourself this: what has the AIG bailout got to do with mortgage guarantees?

    I dunno, everything? Grow Up! Is not an answer.

    They would have written those CDO swaps regardless.

    On stuff that wasn’t toxic. The AIG bailout lets the whole thing happen over again. The US mortgage market has collapsed every 25-30 years since FDR started this rot.

  26. Kool Aid Kid

    Dotted: grow up is the only answer for RobMWs childishness. This is a real problem that is getting bigger. And this log is supposed to be adult. Or am I wrong?

    And now you tell us that AIG underwriting CDOs that funded a market with no credit standards is not to create a toxic exposure? Please assure us that you do not have a job with any financial duties?

  27. Eyrie

    What if the sabotage of the world’s economies is deliberate? Maybe the criminal gangs(governments) have all decided to reduce emissions to “save the planet” by depressing economies?
    After all TPTB (pollies, banksters and other criminals) aren’t suffering?

  28. .

    No credit standards? No. Worse.

    It was subsidised to have poor standards by mandate. How does bailing out AIG, after the fact, where the same rules apply into the future, help?

    What I said is right before. I have no idea why Rob went off into such an abusive tangent.

  29. Kool Aid Kid

    Dot. Bailouts will recur. The financial markets have tested the no liability theory and it works. That is the problem. My point is that these guys make bailouts inevitable.

  30. .

    The rules have not changed. They still have all the stupid rules on lending. This will lead to another crash. You reckon they rely on politicians caving in, so I’d say another bailout is inevitable as well.

  31. Kool Aid Kid

    It’s not the rules Dot. It’s the fact that financial institutions are too big and too willing to risk failure because they know that Washington will bail them. Here in oz the most blatant recent example was tricontinental, which should have been allowed to sink. But it wasn’t – for purely political reasons. And the beneficiaries of that cynicism are still with us in a market where bank balance sheets are time bombs.

  32. .

    So no recourse mortgages, the US Treasury giving GSEs trillion dollar lines of credit, HUD directives ensuring poor areas get mortgages, HUD subsidised PMI and the CRA etc aren’t the rules regarding the US mortgage market anymore?

    You’re right but the US mortgage market is toxic from the outset.

  33. Tel

    Tel: ask yourself this: what has the AIG bailout got to do with mortgage guarantees? The answer is nought.

    I’m pretty sure I never even mentioned the AIG bailout so what’s your point?

    Government can do more than one stupid thing you know.

  34. Tel

    Dot. Bailouts will recur. The financial markets have tested the no liability theory and it works.

    Well it works for some but not for others. What you are trying to claim is that the voting public are too stupid to participate in a democracy, because they have no ability to learn. If this is true then the problem fixes itself and they end up no longer participating in a democracy.

  35. Kool Aid Kid

    Dot and Tel: my point is that the financial sector is unaffected by the recent debacle. The bailouts have confirmed the moral hazard as moral failure and all the signs are in place for another, bigger debacle. Countries with heavy household debt burdens like this one are already demonstrating the initial effects and I imagine that others who’ve been lax like Turkey and Brazil will get hammered when the U.S. Fed is finally forced to turn off the liquidity tap.

  36. Lem

    Good luck Steve Kates, I have read your article and the subsequent discussion, and although you have no need to convince me in a debate, I doubt very much you will convince a banker anywhere in the world as the financial system now stands, about the necessity of prudence, and backing your borrowings with real assets. The system is stacked against it, and destined to failure. All ordinary people can do is try to mitigate against the inevitable harm.

  37. Rob MW

    KAK – Your first comment amigo is where you said:

    “Yet again Steve: you fail to differentiate arse from elbow. It was fake financing that inflated and then blew up the US housing market. Not the other way. And it is an excess of financial influence inthe Australian economy – all driven by public policy interventions – that crafts our next problems.”

    In response to Steve who had written:

    “The GFC was not, obviously not, caused by a failure of demand. It was not caused by too much saving. In America, it was the product of a crash in the housing industry that fed into its financial system. In the rest of the world, the problem was entirely financial, with credit frozen across the globe.”

    The problem with your statement is that Steve is right, it was in fact: – “In America, it was the product of a crash in the housing industry that fed into its financial system.” – caused by Clinton’s desire to severely boost home ownership particularly for low income families. Home ownership, amigo, is the “housing industry” which was the Policy egg that created to the GFC chicken.

    But don’t take my word for it: From the Link

    “There really isn’t any question of which approach is factually correct: right on the front page of the Times edition of December 21 is a chart that shows the growth of home ownership in the United States since 1990. In 1993 it was 63 percent; by the end of the Clinton administration it was 68 percent. The growth in the Bush administration was about 1 percent. The Times itself reported in 1999 that Fannie Mae and Freddie Mac were under pressure from the Clinton administration to increase lending to minorities and low-income home buyers–a policy that necessarily entailed higher risks. Can there really be a question, other than in the fevered imagination of the Times, where the push to reduce lending standards and boost home ownership came from?

    The fact is that neither political party, and no administration, is blameless; the honest answer, as outlined below, is that government policy over many years caused this problem. The regulators, in both the Clinton and Bush administrations, were the enforcers of the reduced lending standards that were essential to the growth in home ownership and the housing bubble.

    THERE ARE TWO KEY EXAMPLES of this misguided government policy. One is the Community Reinvestment Act (CRA). The other is the affordable housing “mission” that the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were charged with fulfilling.

    As originally enacted in 1977, the CRA vaguely mandated regulators to consider whether an insured bank was serving the needs of the “whole” community. For 16 years, the act was invoked rather infrequently, but 1993 marked a decisive turn in its enforcement. What changed? Substantial media and political attention was showered upon a 1992 Boston Federal Reserve Bank study of discrimination in home mortgage lending. This study concluded that, while there was no overt discrimination in banks’ allocation of mortgage funds, loan officers gave whites preferential treatment. The methodology of the study has since been questioned, but at the time it was highly influential with regulators and members of the incoming Clinton administration; in 1993, bank regulators initiated a major effort to reform the CRA regulations.

    In 1995, the regulators created new rules that sought to establish objective criteria for determining whether a bank was meeting CRA standards. Examiners no longer had the discretion they once had. For banks, simply proving that they were looking for qualified buyers wasn’t enough. Banks now had to show that they had actually made a requisite number of loans to low- and moderate-income (LMI) borrowers. The new regulations also required the use of “innovative or flexible” lending practices to address credit needs of LMI borrowers and neighborhoods. Thus, a law that was originally intended to encourage banks to use safe and sound practices in lending now required them to be “innovative” and “flexible.” In other words, it called for the relaxation of lending standards, and it was the bank regulators who were expected to enforce these relaxed standards.

    The effort to reduce mortgage lending standards was led by the Department of Housing and Urban Development through the 1994 National Homeownership Strategy, published at the request of President Clinton. Among other things, it called for “financing strategies, fueled by the creativity and resources of the private and public sectors, to help homeowners that lack cash to buy a home or to make the payments.” Once the standards were relaxed for low-income borrowers, it would seem impossible to deny these benefits to the prime market. Indeed, bank regulators, who were in charge of enforcing CRA standards, could hardly disapprove of similar loans made to better-qualified borrowers.”

    Further reading and an apology to Steve would be welcome.

  38. Andrew M

    I humbly request an explanation as to how the TARP bailouts were not also a stimulus.
    Either way the taxpayers have to pay back government’s debt for issuing that loan, but it seems like a stimulus regardless of whether it is sent to banks or to consumers. In the latter it’s stimulating demand. Probably the wishful thinking around here is that TARP stimulates production, not demand, but that’s assuming the banks use the money to finance projects of real value, rather than settle all their inter-bank funny money liabilities, such as CDOs of toxic mortgages and failed projects which were never going to pay off and therefore can’t create production.

    Further, if the TARP bailouts were a stimulus then how is that not a Keynesian stimulus?

    I agree with the Dot that the rules have to change to prevent a re-occurrence of bad outcomes for the market and society. I’m reluctant to back a particular solution until I understand the forces involved.

  39. don coyote

    I believe that Paul Klugman is coming to the Festival of Dangerous Ideas.

    Aptly named perhaps

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