Sunday, September 30, 2012

Yes, the government CAN do something about recession and depression

Jared Bernstein recently gave a couple of basic explanations about how fiscal and monetary policy create jobs: the oddly titled Daddy, Where Do Jobs Come From? Huffington Post 09/15/2012 and Do Politicians Really Have Much to Do with Job Creation? On The Economy 09/09/2012.

The latter article mentioned addresses something that is often said but seldom questioned in a really critical way, which is how successful the various special tax deals and so forth that states and localities offer to businesses really are in attracting business. Or not.

This part from the Huffington Post piece describes how fiscal policy works:

... though economists tend to discuss fiscal policy as a lump, it actually comes in a lot of different flavors and they're not all created equal in terms of bang-for-buck job creation. Basically, the more indirect they are -- the more links in the chain between the policy and job creation--the less effective they are.

For example, for a stimulative tax cut to create a job, a) the recipient must spend, not save, the money from the cut, and b) she must spend it on domestic goods (I mean, of course, that's what has to happen for the tax cut to create a job here as opposed to in China). Again, if you're in a deleveraging cycle, step "a" is a problem. Also, if your tax cuts go to wealthy people who are not income constrained in the first place, don't expect much in terms of job creation.

Other fiscal measures have more reliable job-creation chains. Increasing unemployment benefits or food stamps helps because those folks typically spend the money. And new infrastructure is a pretty direct way to go. Same with state fiscal relief. I remember during the Recovery Act, mayors cancelling planned layoffs the day they received Recovery Act funds.

The punch line is a simple one, but it's one that seems to have been forgotten amidst our increasing love affair in America with laissez-faire economics: the more direct the policy measure -- i.e., the fewer links in the chain between the policy and the job -- the better it will work.
In other words, even programs that create what detractors call "make-work jobs" would benefit the economy and help to end the depression. Because making work is the point!

Bernstein's description of the effects of monetary policy are in line with mainstream economics and these days would be shared by most "neo-Keynesians", which is how most Keynesian economists would identify themselves. But it was once more common among Keynesians to dismiss the effectiveness of monetary policy altogether. John Kenneth Galbraith in his famous book The Affluent Society (1958) treated monetary policy with the restrained and urbane scorn which was one of the distinctive characteristics of his writing.

The idea that central bankers exercise some arcane and effective power to influence the course of economic events by manipulations of the interest rate based on their rare knowledge of the mysteries of finance, he wrote, "came to have a compelling charm for all who were in any way identified with it. This was especially true of the banking community."

Monetary policy was graced by effects not only mysterious but magical.

This has not invariably been so. In the nineteen thirties the prestige of monetary policy was, for a time, very low. High interest rates had failed miserably to arrest the speculative boom of the late twenties; low rates were equally ineffective in dealing with the Great Depression. Bankers, in these years, as a result of error, unhappy accident, and the enthusiastic denigration of left-wing critics, had suffered a severe decline in popular esteem. Down with them went the faith in monetary policy. Keynes argued that the rate of interest was a roundabout way of influencing economic activity and of small practical utility.
I posted last year about Galbraith's continued skepticism over monetary policy in his last book published during his lifetime, The Economics of Innocent Fraud: Truth for Our Times (2004) in Paul Krugman, fiscal policy and the Federal Reserve 08/30/2011. He wrote in that book:

Quiet measures enforced by the Federal Reserve are thought to be the best approved, best accepted of economic actions. They are also manifestly ineffective. They do not accomplish what they are presume to accimplish. Recession and un employment or boom and inflation continue. Here is our most cherished and, on examiniation most evident form of fraud.
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