Opinion

There he goes again. What gets me is how unprofessional the whole thing is.

Look, if you’re a public figure of any kind, you’re going to face a lot of criticism. Much of it will seem unfair to you; some of the unfair criticism will come from people you expected to take your side; you’ll be angry, you’ll feel that people are putting their egos or their personal aggrandizement above the cause.

Welcome to reality. It’s my reality — and I’m just a professor/columnist. Someone actually in the White House has to be prepared for much more of this kind of thing — and if you don’t have a thick enough skin to take it, find another form of employment.

I’m not saying to turn the other cheek and always say something polite as a general principle; by all means lash out at your critics, if you have something to gain by doing so. Rudeness at the proper moment can serve a purpose — as I hope I’ve demonstrated over the years. But if you vent for the sake of venting; if you alienate people you’re going to need; then you’re just being stupid.

And that, I’m afraid, is what’s going on here. Rachel Maddow isn’t going to go away, or turn all meek, because the White House Press Secretary implicitly denounced her. Even more to the point, liberal critics have an audience because they’re reflecting real concerns of real people. Those concerns need addressing, if necessary in the form of explanations of why their expectations can’t be met. Denouncing the people giving voice to those real concerns as the “professional left” is both unfair and, as I’ve said, stupid.

And both the president and, more important, the country deserve better.

Has the Washington Post gone mad? asks Dean Baker, reading the Post’s latest editorial on Social Security. The answer is no: it has been mad all along.

Dean points out, correctly, that the Post’s argument here is: “In the future, Social Security might have to cut benefits. To prevent these possible future benefit cuts, we must cut future benefits.”

But this isn’t new — the same argument was rolled out in 2005.

A lot of the Beltway establishment has a thing about Social Security — in a way, by the way, they don’t have a thing about Medicare, which is a vastly more important long-run problem. No matter how much you talk logic or numbers, they’re obsessed with the idea that Social Security must be cut; as I wrote back when, somewhere back in the 90s talking tough on Social Security became a badge of seriousness, and facts just can’t make a dent in that social convention.

At the end of the new Reinhart-Rogoff paper is a graph showing total US debt — public and private — as a share of GDP:

Reinhart and Rogoff

It’s not entirely clear what the point of the graph is, although I think it’s to point out that when you look at overall debt, we’re in uncharted territory; fair enough, although a lot of that debt is owed by the financial system to itself.

But I think it’s important to look at the previous peak, in the early 30s. Here’s a closeup of that period:

Historical Statistics of the United States, Millennial Edition

So, in the aftermath of the financial crisis the government went deep into debt, and that’s what’s driving the spike, right?

Um, no. Here’s debt in dollar terms:

Historical Statistics of the United States, Millennial Edition

Debt actually fell as the economy slumped, through a combination of deleveraging and default. The ratio to GDP spiked only because GDP collapsed. Conversely, as the economy began to recover under the New Deal (before the big mistake of 1937), the debt ratio improved thanks to rising GDP, even though the nominal level of debt also rose.

What all this tells you is how important it is, in dealing with debt, to get the economy moving — and how devastating it is, even if you’re deeply frugal, if contraction and deflation rule.

So R-R have a new article in Vox that, they say, aims to “clarify matters”. I don’t feel clarified.

The original paper on debt and growth presented a stark correlation between high debt and low growth, and seemed to say that this was a causal relationship. In practice, the article has been widely used to claim that there’s a red line of 90 percent in the public debt to GDP ratio that one crosses at one’s peril.

Skeptics like me quickly questioned the causal interpretation of the correlation. We pointed out that in the case of the United States, highlighted in the original paper, the debt-growth correlation came entirely from the immediate postwar years, when growth was low thanks to postwar demobilization. We pointed out that other episodes of high debt and low growth, like Japan since the late 1990s, were arguably cases in which causation ran from collapsing growth to debt rather than the other way around.

So surely the question is how much of the correlation survives once we restrict ourselves to cases in which the causation is plausibly from debt to poor growth, rather than likely being spurious or reversed.

But R-R don’t offer any response to that question. They do give us a list of peacetime high-debt episodes:

the 1920s and 1980s to the present in Belgium,
the 1920s in France,
Greece in the 1920s,
1930s and 1990s to the present,
Ireland in the 1980s,
Italy in the 1990s,
Spain at the turn of the last century,
the UK in the interwar period and prior to the 1860s and, of course,
Japan in the past decade.

If I’m reading this right, then the postwar cases other than Japan — which I’ve argued looks like reverse causation — are Belgium, Ireland, and Italy. Are these cases enough to bear the weight now being placed on that supposed 90 percent red line?

I’m also puzzled by the way R-R deal with the reverse causation argument: they admit it can happen, but argue that causation doesn’t always run from growth to debt, but can run the other way. Isn’t that attacking a straw man?

Anyway, I come out of this with no more clarity than I had going in; I still don’t know what, if anything, the R-R data tell us about the growth effects of debt at the levels now in prospect.

OK, I suppose I should react to this article about how geography, not the exchange rate, explains China’s surplus. Or maybe that’s not what it said. Frankly, I found the thing kind of a head-scratcher.

Yes, the emergence of a huge core-periphery pattern has been a major theme in China’s takeoff, and that’s a gratifying vindication of some of my academic work; indeed, I’ve taken to using China as an illustration of “new economic geography” themes. But I don’t at all understand the logic of the author’s conclusion that this means we shouldn’t pressure China to end its currency manipulation. As far as I can tell, that just pops out of thin air.

And one thing I think people don’t sufficiently realize: China has not been running large surpluses throughout its economic boom. On the contrary, those large surpluses are a relatively recent development:

IMF

To me, this suggests that the surpluses, and the currency manipulation, are neither intimately related to Chinese growth nor necessary for that growth to continue.

As of right now, the 10-year bond rate is 2.71 percent. As you can see from the chart above, this puts it back where it was in the early spring of 2009 — higher than it was during the Oh-my-God-we’re-all-gonna-die period of winter 2008-2009, but lower than anything else we’ve seen for decades.

As it happens, interest rates are also now lower than they were when the big debate over fiscal policy and its interest-rate effects began. For those who don’t remember or don’t know, this started with the claim that government borrowing would send rates soaring, crowding out private investment, and that this would abort the recovery. I tried at the time to point out that this reflected a failure to understand basic macroeconomics; but as usual, made no headway with the culprits.

Said culprits then claimed that rising interest rates in the months following, rather than reflecting improved expectations about the economy, confirmed their view.

Later they changed their stance, claiming that the real problem was rising debt threatening solvency, and that America was going to be Greece any day now.

What we actually see is exactly the story those of us who knew their Hicks told from the beginning: short rates hard up against zero as long as the economy remains deeply depressed, long rates fluctuating based on changing beliefs about how long it would take for the economy to recover sufficiently for the Fed to begin tightening.

And anyone who believed the stuff about invisible bond vigilantes, and acted on it, has lost a lot of money.

Look at the lower left-hand corner: the real interest rate on 5-year inflation-protected securities is now negative. In other words, prospects for other investments are so poor that some investors prefer a safe asset that doesn’t quite keep up with inflation.

Yet to maintain employment, we need to sustain spending, one way or another. One way is to have the government take advantage of its low financing costs to spend on useful things; but the deficit peacocks in Congress are blocking that solution. Another is to get real interest rates low enough to get the private sector spending; but that, as we can see, means that the real interest rate on medium-term government debt has to be negative.

The only way you can do that is by having the Fed credibly promise to deliver significant inflation.

Oh, and the invisible bond vigilantes continue their invisible attack: nominal 10-year bonds at 2.71%.

The FOMC has spoken. What’s my reaction? The Fed’s current policy is grossly inadequate, logically bizarre, and slightly — but only slightly — encouraging.

What the FOMC announced was a slight change in policy: rather than allowing its balance sheet to shrink as the mortgage-backed securities it owns mature, it will maintain the balance sheet’s size by reinvesting the proceeds in long-term government bonds. Roughly speaking, it has gone from a completely crazy policy of monetary tightening in the face of massive unemployment and incipient deflation, to a policy of standing pat in the face of same. Whoopee.

And it’s a very strange decision, if you think about it. Presumably there’s some optimal size of the Fed’s balance sheet, given the state and prospects of the economy. What are the odds that the optimal size of that balance sheet is precisely the size it’s currently at? Bear in mind that the Fed’s current balance sheet reflects the legacy of policies undertaken when both fear of a complete meltdown and the expected pace of recovery once that fear abated were very different from what they are now.

So why freeze the size of the balance sheet right where it is? The answer is that it was, literally, the least the Fed could do. If it had continued to let the balance sheet shrink, the reaction both from Fed critics and from the markets would have been terrible. In effect, reinvesting the funds from expiring securities became a focal point, an essentially arbitrary location in the space of policy responses that nonetheless had come to have “salience”, because it was what everyone was watching.

So why am I even slightly encouraged? Because the critics did, at least, succeed in moving the focal point. Not long ago gradual Fed tightening was the default strategy; but as I said, at this point the Fed realized that continuing on that path would have unleashed both a firestorm of criticism and a severe negative reaction in the markets.

What we need to do now is keep up the pressure, so that at the next FOMC meeting the members are once again confronted by the reality that not changing course would be seen as dereliction of duty. And so on, from meeting to meeting, until the Fed actually does what it should.

I know: it’s a heck of a way to make policy. In a better world, the Fed would look at the state of the economy and do what was right, not the minimum necessary. But wishing for that kind of world is like wishing that Ben Bernanke were running the place.

A lot of commentary about the anti-left outburst by Robert Gibbs points out, correctly, that it was really dumb from a political perspective; criticism from the left is not a significant problem for Obama, while annoying the base is.

But I think people are missing an important point: what’s good for Obama is not necessarily good for his aides.

Think about it: Complaints that the administration should have pursued a bigger stimulus, or fought harder for the public option, or taken a different position on Afghanistan aren’t going to matter in the midterms. But they might hurt White House aides who argued against a bigger stimulus (to the point of not even passing the option on to the president), or argued against a harder push on health reform (perhaps even calling for retreat after Scott Brown), or have argued that continuation of Bush foreign policy is a political winner. The point is that the president might actually take those criticisms to heart, and rethink who he listens to.

Of course, aides aren’t supposed to put their own interests above those of the man they serve. And they probably aren’t doing that consciously. But still ….

A language thing: many people have been characterizing my attack on the Ryan roadmap as “ad hominem.” I think this represents a devaluation of the term.

As I’ve always understood it, ad hominem attacks involve attacking the person in general rather than what the person has to say on a specific issue. It means that instead of saying that Professor X seems to have played fast and loose with the data in his latest study, you say that Professor X’s mother was a hamster and his father smelt of elderberries; or, to take some non-random examples, you habitually refer to someone as “former Enron consultant Paul Krugman,” or invariably bring the size of Al Gore’s house into discussions of climate change.

Now, I didn’t do anything like that. I did point out that Ryan appears to be faking it in the selling of his plan — and I documented that assertion with specifics on the plan, on how he gamed the CBO process, and on the differences between how he talks about the deficit and what his plan would actually do.

That’s not ad hominem; it’s just being blunt.

The renewal of claims that tax cuts pay for themselves has led to a revival of discussion about an old question: how high do taxes have to be before further increases actually reduce revenue?

So I thought it might be worth thinking about this question in terms of a simple model of labor supply. Think of an individual facing a marginal tax rate t; and think of the amount this individual produces as depending on effort, which in turn depends on how much of his or her income the individual gets to keep at the margin, i.e., 1-t. Then a little calculus will show that whether a tax hike increase raises or lowers revenue depends on whether the elasticity of effort with respect to earnings — the percentage change in effort from a 1 percent rise in 1-t, the after-tax return to effort — is less or more than (1-t)/t.

An example may make the point clear. Suppose that the top marginal tax rate is 20 percent, so that high earners get to keep 80 percent of what they make. Now raise the rate to 21 percent. This is a 5 (100*1/20) percent increase in the proportion of income collected in taxes; revenue will only fall if effort falls more than 5 percent. Meanwhile, the after tax return to effort falls 1.25 percent (100*1/80). So the elasticity of effort with respect to earnings would have to be more than 4 for revenue to fall.

At a marginal tax rate of 50 percent, the break point is much lower; just 1. And so on.

So what do we know about the elasticity of effort with respect to earnings? Well, history suggests that if anything it’s negative: real wages have trended up over time, but working hours have fallen. That’s not a paradox, because rising wages have an income as well as a substitution effect. When you get richer, you want in general to consume more of everything, and among the things you want to consume is leisure. Against this,you can buy more goodies with an additional hour of work; but the net effect can go either way.

Now, someone might come along and point out that higher taxes aren’t the same thing as lower wages, because those taxes are generally used to finance a more generous welfare state — and this can wash out the income effect. That is, if you impose taxes that bring incomes after tax back to what they were in, say, 1960, but use the revenue to finance generous retirement benefits and free medical care, you should not expect people to work as hard as they did in 1960. And that’s a good point when we’re talking about the effects of high taxes/high benefits for people in the lower part of the income distribution.

But it’s not very relevant to high earners, for whom welfare-state benefits are inevitably small compared with their overall incomes.

So the way I see it, even quite high marginal tax rates on high earners — even rates in, say, the 70 percent range that prevailed pre-Reagan — are unlikely to put us on the wrong side of the Laffer curve by discouraging effort. High earners won’t work much less; they might even work harder, because it takes more effort to make enough to buy that fourth home.

That doesn’t mean, however, that it’s OK to go back to Eisenhower-era 91 percent top marginal rates. The problem with super-high rates isn’t so much that they reduce incentives to work; it’s that they create huge incentives to avoid or evade.

But we’re nowhere near Laffer country now. In terms of taxes and revenue, up is up, down is down.

Everyone knows that the American right has problems with science that yields conclusions it doesn’t like. Climate science — which says that we face a huge global externality that requires not just government intervention, but coordinated international action (black helicopters!) has been the target of a sustained, and unfortunately largely successful, attempt to damage its credibility.

But it doesn’t stop there. We should not forget that much of the right is deeply hostile to the theory of evolution.

And now there’s a new one (to me, anyway; maybe it’s been out there all along): it turns out that, according to Conservapedia, the theory of relativity is a liberal plot.

Update: Tom Tomorrow emails me to tell me about today’s comic.

Jonathan Chait Cohn tells us that public-sector employees are the new welfare queens. Quite: any time you try to talk about the fiscal plight of state and local government, you get spittle-flecked denunciations of unions and their crazy pay packages.

So, how much truth is there to this? State and local employees are paid more, on average, than private-sector workers — about 13 percent more, according to this analysis by John Schmitt. But as Schmitt shows, that’s an apples and oranges comparison: state and local workers are much better educated and somewhat older than private-sector workers, and once you correct for that the comparison actually seems to go the other way.

I think the easy way to think about this is to realize that about half of state and local workers are teachers and academic administrators — which means that they’re college-educated, at minimum. And think about it: how many ambitious young people do you know saying, “My goal in life is to become a high school teacher — that would put me on easy street”?

Yes, firefighters and police get pretty generous pay packages; they also pull people from burning buildings.

And here’s a point I haven’t seen made: even if you believe that the age-and-education-adjusted calculations are wrong, and public employees do get paid somewhat more than they “should”, how big a deal is that? I went to the Census state and local finance data, and got this picture of the composition of non-federal government spending:

U.S. Census Bureau

A few percent either way in workers’ compensation would not make a big difference to state and local spending. This is a phony issue.

Of course, so were the welfare queens.

Update: A number of commenters have alluded to large unfunded pension liabilities. Two points: first, the fact that state and local governments haven’t been making large enough contributions to pension funds says nothing, one way or the other, about whether workers are overcompensated. Bear in mind that, as Cohn notes, many government employees don’t get Social Security. Second, a “trillion dollar liability” needs to be placed in context: state and local governments spend $2.8 trillion per year. Compare the pension liability with total spending over, say, the expected remaining lifetimes of those workers, and it’s a real problem but not inconsistent with my point that these compensation issues have been grossly overstated.

Should it bother me that throughout Ian McDonald’s Brasyl, units of Brazilian currency are described as reis, when I know, as an old Latin American crisis hand, that the plural of real is reais?

Reading Jon Hilsenrath’s column today, I was initially a bit skeptical about this assertion:

When Japan fell into deflation in the 1990s, Mr. Bernanke, then a Princeton professor, urged the Bank of Japan to set an objective of 3% to 4% inflation. The reason: With interest rates pinned at zero, rising inflation would mean that the real cost of borrowing, which is nominal interest rates minus inflation, would be falling. In theory that would spur demand.

I knew that I had pushed that option (pdf); I was less sure that Bernanke had, since he often focused more on quantitative easing. But Hilsenrath is right: Bernanke did say that, in a paper poignantly titled Japanese Monetary Policy: A Case of Self-Induced Paralysis? (pdf). Here are some relevant passages:

A problem with the current BOJ policy, however, is its vagueness. What precisely is meant by the phrase “until deflationary concerns
subside”? Krugman (1999) and others have suggested that the BOJ quantify its objectives by announcing an inflation target, and further that it be a fairly high target. I agree that this approach would be helpful, in that it would give private decision-makers more information about the objectives of monetary policy. In particular, a target in the 3-4% range for inflation, to be maintained for a number of years, would confirm not only that the BOJ is intent on moving safely away from a deflationary regime, but also that it intends to make up some of the “price-level gap” created by eight years of zero or negative inflation.

…

BOJ officials have strongly resisted the suggestion of installing an explicit inflation target. Their often-stated concern is that announcing a target that they are not sure they know how to achieve will endanger the Bank’s credibility; and they have expressed
skepticism that simple announcements can have any effects on expectations.

…

With respect to the issue of inflation targets and BOJ credibility, I do not see how credibility can be harmed by straightforward and honest dialogue of policymakers with the public. In stating an inflation target of, say, 3-4%, the BOJ would be giving the public information about its objectives, and hence the direction in which it will attempt to move the economy. (And, as I will argue, the Bank does have tools to move the economy.) But if BOJ officials feel that, for technical reasons, when and whether they will attain the announced target is uncertain, they could explain those points to the public as well. Better that the public knows that the BOJ is doing all it can to reflate the economy, and that it understands why the Bank is taking the actions it does. The alternative is that the private sector be left to its doubts about the willingness or competence of the BOJ to help the macroeconomic situation.

The poignant thing is that at this point you could replace “BOJ” by “Fed”, and these remarks would be a completely accurate description of the self-induced paralysis of monetary policy right here in River City.

Tim Duy tells us that

Word on the street is that Fed staff are increasingly frustrated with the lack of action from leadership. Why exactly is Bernanke showing such deference to the more hawkish elements such as Kansas City Federal Reserve President Thomas Hoenig, Dallas Federal Reserve President Richard Fischer, and Philadelphia Fed President Charles Plosser? If you seek more easing, you are not alone. Board staff are increasingly your allies.

I hope that’s right. But things would be very different if only Ben Bernanke were Fed chairman!