Apparently there’s a lot of discussion about the sources of the miraculous resilience of Texas in the current slump, with the usual suspects claiming that it proves the virtues of capitalism red in tooth and claw, or something.

Except that a quick look at state unemployment rates doesn’t suggest anything especially miraculous going on:

Unemployment in Texas has, in fact, risen sharply; not as much as in Michigan, Nevada, or California, but more or less comparable to New York and Taxachusetts. Strangely, though, we aren’t hearing about how the wonderful policies of the Paterson administration spared New York from harm.

What is true is that the Texas budget is in relatively good shape. That’s because recessions don’t do as much fiscal damage if you have a weak safety net, so expenses don’t rise much as people are plunged into poverty (because they don’t get any help), and a regressive tax system, so that revenues don’t fall much when incomes collapse.

Some miracle.

Whenever I point out that bond markets are not, in fact, demanding immediate fiscal austerity, I get comments along the lines of “So now you believe markets are perfect?” That’s missing the point. The starting point for the argument people like me make is that markets shouldn’t be demanding immediate austerity, because the long-run fiscal effects of short-run deficits are relatively small; the burden of proof is therefore on the other side to show that markets will demand something they shouldn’t.

Think of the dialogue as going like this:

Stimulist: Yes, long-run fiscal issues matter — but what we spend now is virtually irrelevant to those issues. A trillion dollars of spending will raise real interest costs by less than 0.1 % of GDP, and might even help the long-run position by avoiding a permanent loss of potential output.

Austerian: No, we must cut immediately to satisfy the bond market!

Stimulist: But the bond market isn’t demanding immediate cuts — it seems quite unworried by current deficits.

Austerian: But I know what the bond market will want, never mind what it’s saying now.

So the stimulists are saying that the fundamentals look OK, and there’s no obvious reason to disregard those fundamentals; the austerians are saying that we need to pursue economically irrational policies in order to satisfy demands that markets shouldn’t make and, in fact, aren’t making.

But they’re Very Serious People.

One of the things everyone knows right now is that Obama has presided over a huge increase in government spending. But like so many of the things everyone knows, it isn’t true.

A few considerations to bear in mind:

1. You don’t want dollar amounts, especially when comparing over time; you really want to scale spending by the size of the US economy.

2. But even dividing by GDP isn’t quite enough, because we’re still a deeply depressed economy, so government spending as a share of GDP will look high even if actual spending hasn’t risen at all, simply because it’s divided by a smaller number. So a better guide is spending as a share of potential GDP, for which I use the CBO measure.

3. You really want to consolidate federal spending with state and local — especially because a significant part of the stimulus was aid to state and local governments designed to help them limit spending cuts.

So what do the numbers look like when you look at total government spending as a percentage of potential GDP?

At first sight, it depends on how you measure government spending. If you consider government consumption and investment spending — that’s the government actually hiring workers, building roads, employing bureaucrats, and all that — it looks like this:

BEA, CBO

Feel the surge!

What’s going on here? Basically, the Obama stimulus didn’t contain a lot of public works — and those works, such as they are, have only partially come on line. Meanwhile, aid to state and local governments wasn’t enough to prevent substantial cuts. So by this measure, government spending has gone nowhere.

Now, the picture looks a little different if you look at all government spending, a number that includes Social Security, Medicare, and other transfer payments:

BEA, CBO

This has gone up — but why? There haven’t been any large new social programs — health reform, which actually isn’t that big anyway, won’t start spending in earnest until 2014. As best as I can tell, the main cause of the rise in total spending is a surge in spending on safety net programs, which are spending more because more people are in distress. Unemployment insurance alone seems to account for almost half the rise:

In short, the giant increases in government spending we keep hearing about are a myth; if there had been more truth to that myth, the economy wouldn’t be as depressed as it is.

Stan Collender has a terrific piece about the bond market that I wish I had written (I can offer no higher praise). The key takeaway:

It’s clear that the bond market is now giving at least as strong a signal about its desired fiscal policy as it did in the early 1990s. But instead of demanding reductions in the deficit and government borrowing and threatening higher interest rates if those don’t happen, today’s vigilantes are unmistakably saying just the opposite. They want Washington to do more to stimulate the economy, and they welcome the deficit and debt it will take to do it.

In other words, the former bond market vigilantes have now become the biggest supporters of federal deficits and borrowing. I’ll follow in Yardeni’s footsteps and call them bond market deficit cheerleaders.

Just to add a further point: the austerity now now now crowd poses as the sober voices warning governments not to ignore the dictates of all-powerful financial markets. But the signals from the financial markets don’t at all point to a need for early austerity. So what the austerity people are in effect saying is that they are smarter than bond investors — that they know what the bond market is going to want, it just doesn’t know it yet.

And on this basis they want us to ignore the plight of tens of millions of jobless workers.

OK, I know I’m showing my age — but this drives me crazy. In this very good article by Michael Pettis, he keeps writing “principle” when he means “principal.” And this from a financial expert!

It’s something I see all the time. Maybe we’re in the process of losing this distinction — but I say rage, rage, against the dying of the light.

I sort of knew this, but I’m still somewhat amazed to see Tim Geithner’s happy talk in today’s Times.

Here’s the reality: the stimulus was too small; we’re not seeing growth at a pace that will bring unemployment down rapidly, if at all; we clearly should be doing more; but obstructionism from Republicans is preventing action. And the administration knows all this perfectly well.

So one way to play this politically would be to tell the truth, and try to place the onus on Republicans, accusing them of perpetuating high unemployment.

Instead, however, the administration has decided to engage in happy talk, saying that it’s all good.

Do they really think this will work? I mean, I live in fairly rarefied circles (that’s not a boast, it’s an admission of inadequacy), and even so I know a number of people whose lives have become a living hell: men in their late 50s who fear they’ll never work again, small business owners who have lost everything. Does the administration really believe that it can convince these people that it’s all on the mend?

I just don’t get it.

Increasing Returns and Economic Geography (pdf) was, I think, my best academic paper; economists apparently think so too, putting it at the top of the list on Google Scholar. Now Charlie Stross, my favorite contemporary science fiction author, takes on the issue of increasing returns and their implications for, among other things, the possibility or lack thereof of space colonization:

Space colonization? Get back to me when you’ve tracked down how many people it takes to design and build a space suit. (The number is in the hundreds, if not the thousands.) More realistically, we won’t have autonomous off-world colonies unless and until they can cover all the numerous specialities of the complex civilization that spawned the non-autonomous, dependent-on-resupply space program. Or, to put it another way: colonizing Mars might well be practical, but only if we can start out by plonking a hundred million people down there.

Go read. And while you’re at it, read Henry Farrell’s related post on technological retrogression in societies with too few people.

A number of readers have asked me to explain why deflation is a bad thing; and the truth is that while I’ve alluded to the issue a number of times, I’m not sure if I’ve ever laid out the whole case. So here goes.

There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow. After all, when prices are falling, just sitting on cash becomes an investment with a positive real yield – Japanese bank deposits are a really good deal compared with those in America — and anyone considering borrowing, even for a productive investment, has to take account of the fact that the loan will have to repaid in dollars that are worth more than the dollars you borrowed. If the economy is doing well, all this can be offset by just keeping interest rates low; but if the economy isn’t doing well, even a zero rate may not be low enough to achieve full employment.

And when that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. That’s the deflationary trap we keep worrying about.

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts. Now, you might think this is a zero-sum affair, since creditors experience a corresponding gain. But as Irving Fisher pointed out long ago (pdf), debtors are likely to be forced to cut their spending when their debt burden rises, while creditors aren’t likely to increase their spending by the same amount. So deflation exerts a depressing effect on spending by raising debt burdens – which, as Fisher also points out, can lead to another kind of vicious circle, in which depressed spending because of rising real debt leads to further deflation.

Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity. What this means is that in general economies don’t manage to have falling wages unless they also have mass unemployment, so that workers are desperate enough to accept those wage declines. See Estonia and Latvia, cases of.

Now, alert readers will have noticed that none of these arguments abruptly kicks in when the inflation rate goes from +0.1% to -0.1%. Even with low but positive inflation the zero lower bound may be binding; inflation that comes in lower than borrowers expected leaves them with a worse debt burden than they were counting on, even if the inflation is positive; and since relative wages are shifting around all the time, some nominal wages will have to fall even if the overall rate of inflation is a bit above zero. So the argument that deflation is a bad thing is also an argument saying that some economic problems get worse as inflation falls, and that too low an inflation rate may actually be economically damaging. That’s why the fact that inflation, while still positive, is below the Fed’s target is bad news; and it’s why respectable people like Olivier Blanchard (pdf) have suggested that a higher target, something like 4 percent inflation, might make sense.

And no, 4 percent inflation wouldn’t turn us into Zimbabwe. I remember when we had stable inflation of around 4 percent – and it was morning in America.

Update: Whoa, I wrote this post while away from teh Internet, and posted before seeing the 787 billion comments on this subject.

From the WSJ:

Some of the world’s leading investors are becoming more worried about deflation and are re-shaping their portfolios to prepare for a possible period of falling prices.

Bond-fund heavyweight Bill Gross, investment manager Jeremy Grantham and hedge-fund managers David Tepper and Alan Fournier are among the best-known investors who are bracing for a possible bout of deflation, a development that could cripple global economies and world stock markets.

The investors cite weak economic figures and a mounting consensus that global policy makers are reluctant, or unable, to take further steps to boost economic growth as reasons for their market positions.

But, but AP told us just a few days ago that deflation was a remote possibility.

Lucy Kellaway on hedge fund types who draw inspiration from vampires:

A few days earlier I had been forwarded a memo written by the hedge fund chief Tom Barrack to his underlings at Colony Capital. In it, he described a “personal breakthrough” he had made as a result of reading the Twilight books. “I feel renewed and refreshed, having gotten out of my comfort zone and experiencing something so totally out of my normal realm,” he wrote.
…
It goes on to describe how after “an agonisingly tough couple of weeks” he took some “yacht time” and chanced upon his daughter’s copy of Twilight. “I don’t get it … but I feel it. Taking the agenda-less time to absorb a point of view that I had ignored while loved ones around me relished it was an oasis for my soul.”

There are long musings on love, on anticipation and vampires, allowing him to draw the following conclusion for his team: “It is hard for us to dream … it is time for all of us … to spend more time outside the strict arithmetic cadence of our business … we must really find the ‘moment’ …”

There is no time to answer the questions this raises – Why are dreams good for hedgies? Find what “moment”? What is a “strict arithmetic cadence”? – as there is more.

“Move your cheese!!!! … The earth is turning on its axis. Planets and moons and suns are in orbit. Gravity is pulling and tugging, and molecules and quarks are warring inside of us. We need movement to live …”

So I just read the latest speech from Richard Fisher of the Dallas Fed; it’s one of the most depressing things I’ve read lately, and given what I read that’s saying a lot.

Much of the speech is taken up with arguing that it’s not the Fed’s job to help the struggling economy, because the big problem there is business uncertainty about future regulation. Urk. Like others, I’ve tried to point out that there is no evidence for this claim: business investment is no lower than you’d expect given the state of the economy, while surveys say that weak sales, not fear of regulation, are holding back business expansion. Oh, and just to make it perfect, Fisher cites Mort Zuckerman to bolster his case.

But what’s really striking here is the way Fisher basically takes the Fed completely off the hook. Hitherto, the Fed has been charged with two goals: full employment (defined more or less as keeping unemployment near the NAIRU), and price stability, defined as roughly 2 percent inflation. But in this speech Fisher essentially takes down one of those goalposts, arguing that there’s nothing the Fed can or should be doing about the weak economy; and he moves the other post, redefining price stability as “keeping inflation extremely low and stable”.

Now, he does say that “Neither inflation nor deflation will be tolerated.” But I’ll make a prediction: once we’re experiencing deflation, with conventional monetary policy still up against the zero bound, Fisher will still be against doing anything unconventional; instead, price stability will be redefined to be consistent with gradually falling prices.

And here’s an aside: was there ever this much public cacophony among Fed presidents during the Greenspan era? Might we not say that the hard-money men of the Fed are actually helping foster the very deflationary expectations we fear?

One thing readers may not realize is that although this blog is located at the New York Times, it’s essentially a personal not-for-pay venture. It’s mainly a scratchpad where I can try out ideas, lay out some of the data and wonkery behind columns, and blow off steam on matters not worth spending the precious 4830 characters including spaces that the Times grants me twice a week in the column proper.

One of the implications of all this is that comment moderating is, of necessity, something that has to be done quickly. Sometimes Times staffers moderate, basically as a favor to me; sometimes I do it myself; either way, we’re not going to have time to do more than quickly scan to see if there are obscenities and/or if something runs on forever. My 3-inch rule is a rough guide; no, I’m not going to make it precise, because then I and other moderators would have to spend time counting characters or something, and I don’t have that time.

And for the big whiners out there: this is my blog, which I do for free. I welcome a lively discussion, and don’t edit out hostile comments if they’re brief and free of obscenities. But if you want a soapbox for interminable rants, I have no obligation to provide it; go start your own blog, and find your own readers.

Tim Duy has taken my clockwise spirals of disinflation during slumps and put them on a single graph; here’s a cleaned-up version:

Bureau of Labor Statistics

As Duy points out, disinflation hasn’t proceeded as rapidly this time around as in the previous slumps. But what are we to make of this?

One answer is that inflation expectations have been slower to fall, which kind of makes sense: in the 80s, in particular, people gradually woke up to the fact that Paul Volcker really wanted to bring us from a 10-percent-inflation world back down to a 3 or 4 percent world, whereas this time around most people think the Fed will try to get us back to around 2 percent.

But there’s another possibility: we went into this slump with much lower inflation than in previous episodes — and a flattening of the unemployment-inflation relationship at low inflation rates is exactly what you’d expect in the face of downward nominal wage rigidity. So we may be approaching deflation more slowly than some might fear — but only because we live in a world in which excessively low inflation is actually a very bad thing, and we’re already in the problem zone.

Oh, and about the inflation expectations: they don’t look all that anchored over the past 6 months, with the 5-year TIPS spread falling more than half a percentage point since the winter. I wonder if people are starting to realize that the Fed can’t or won’t actually achieve its supposed inflation target.

Do you remember how public hatred of the health care reform was going to be the dominant issue in the midterm elections? Do you remember how there was going to be a firestorm of disapproval over the Democrats’ use of reconciliation to pass the legislation despite the fact that they only had 59 out of 100 Senators?

Neither do I.

I’ll be with the new host of This Week this week — tomorrow.