All posts in category Fiscal cliff

The ultimate sign of recovery – no reason to freak out about higher bond yields

This is from CNBC.com:

U.S. Treasurys prices eased for a second day after jobless claims data suggested solid improvement in the labor market, while stocks’ gains undermined the appeal of lower-risk government debt.

The Treasury Department auctioned $13 billion of reopened 30-year bonds on Thursday at a high yield of 3.248 percent. The bid-to-cover ratio, an indicator of demand, was 2.43, the lowest level since August.

In the when-issued market, considered a proxy for where the bonds will price at auction, 30-year bonds were yielding about 3.24 percent. The auction followed solid demand in the sales of $21 billion of reopened 10-year notes on Wednesday and $32 billion of three-year notes on Tuesday.

US bond yields continue to inch higher. To me that is the ultimate sign that easier monetary conditions is pushing up nominal GDP (and very likely also real GDP).

But I am afraid that we will soon hear somebody warn us that higher bond yields will kill the recovery. But we of course know that when bond yields and equity prices are rising in parallel then it is normally a very good sign of higher aggregate demand and that is of course exactly what we need.

So if we avoid the biggest fallacy in economics and ask why bond yields are rising then we should find a lot of comfort in the fact that US stock prices are rising as well.

And finally there is some Keynesians out there that can explain to me why global stock prices continue to inch up, bond yields are rising and the US consumer seems completely unaffected despite of the fiscal cliff (I told you so!) and the sequester. Market Monetarists of course have an answer – it is monetary policy dominance – monetary policy can always offset any impact on aggregate demand from a fiscal shock. It is very simple – and is the positive spin on the Sumner Critique. (Here is a model textbook Keynesian should be able to understand).

PS yes you got it right – I am very optimistic both on the markets and on the recovery at least in the US (I have been optimistic for a while – see here and here). My only two fears are that the ECB once again will do something stupid or that we will have a repeat of the mistakes of 19367-37 – premature monetary tightening from the fed. Italian politics is, however, not keeping me awake at night.

Update: I wrote above my worry was the ECB. I should have said the EU/IMF. The terms for the EU/IMF bail out of Cyprus scare me quite a bit. So much for the rule of law…

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16 Comments
by Lars Christensen on March 14, 2013  •  Permalink
Posted in Bernanke-Evans rule, Federal Reserve, Fiscal cliff, Sumner Critique
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Posted by Lars Christensen on March 14, 2013

http://marketmonetarist.com/2013/03/14/the-ultimate-sign-of-recovery-no-reason-to-freak-out-about-higher-bond-yields/

Jeff Cox is puzzled – maybe because he never asked anybody about monetary policy

This is CNBC’s Jeff Cox:

Investors who fled in fear over potentially massive tax increases associated with the “fiscal cliff” have barely broken a sweat over corresponding spending cuts that are only two weeks away.

The so-called sequestration of $110 billion a year in discretionary spending will happen March 1 if Congress does not come to an agreement.

With little indication that Washington is anywhere near a compromise similar to the one that avoided the full brunt of the fiscal cliff, markets could be expected to be in full panic mode.

But the post-cliff rally has shown no signs of letting up and the topic has gained little traction around Wall Street.

It is clear that Jeff never read any Market Monetarist blogs. If he had he would have known that monetary policy always overrules fiscal policy – there is monetary policy dominance and therefore financial markets should not be worried about a sizable fiscal tightening.

With the Bernanke-Evans rule the Fed has committed itself to continuing and escalating – if necessary – monetary easing until there is a substantial improvement of US labour market conditions – essentially this is a commitment to increasing aggregate demand. Hence, the Fed is also committed to counteract any negative impact on aggregate demand from a potential tightening of fiscal policy.

I have explained earlier that there is no reason to fear the fiscal cliff as long as there is a ‘monetary backstop’ in the form of the Bernanke-Evans rule:

Even if the fiscal cliff would be a negative shock to private consumption and public spending it is certainly not given that that would lead to a drop in overall aggregate demand. As I have discussed in earlier posts if the central bank targets NGDP or inflation for that matter then the central bank tries to counteract any negative demand shock (for example a fiscal tightening) by a similarly sized monetary expansion.

Even if we assume that we are in a textbook style IS/LM world with sticky prices and where the money demand is interest rate sensitive the budget multiplier will be zero if the central bank follows a rule to stabilize aggregate demand/NGDP.

As I have shown in an earlier post the LM curve becomes vertical if the monetary policy rule targets a certain level of unemployment or aggregate demand. This is exactly what the Bernanke-Evans rule implies. Effectively that means that if the fiscal cliff were to push up unemployment then the Fed would simply step up quantitative easing to force back down unemployment again.

Obviously the Fed’s actual conduct of monetary policy is much less “automatic” and rule-following than I here imply, but it is pretty certain that a 3, 4 or 5% of GDP tightening of fiscal policy in the US would trigger a very strong counter-reaction from the Federal Reserve and I strongly believe that the Fed would be able to counteract any negative shock to aggregate demand by easing monetary policy. This of course is the so-called Sumner Critique.

So Jeff the reason the markets are so relaxed about the so-called sequestration might very well be that the Fed has regained some credibility that it actually is controlling aggregate demand/NGDP. I know it is hard to understand that it is not important what is going on in the US Congress, but the markets really don’t care as long as the Fed is doing its job.

2 Comments
by Lars Christensen on February 16, 2013  •  Permalink
Posted in Bernanke-Evans rule, Federal Reserve, Fiscal cliff, Sumner Critique
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Posted by Lars Christensen on February 16, 2013

http://marketmonetarist.com/2013/02/16/jeff-cox-is-puzzled-maybe-because-he-never-asked-anybody-about-monetary-policy/

The trillion dollar coin is an utterly idiotic idea

Following US political debate these days is like following a bad parody of a third world banana republic and even though I the deepest respect for Americans and US in general I must say it is hard not to agree with those Europeans that shake their heads these days and say “they are stupid those Americans”. Well, it is not the Americans – it is their politicians and you could say a similar thing about Europe.

The latest banana republic gimmick is the suggestion that the US Treasury should use a legal loophole to print a trillion dollar coin in the event that the US congressional majority – that’s the Republicans – would refuse to increase the so-called debt celling.

The idea in my view is completely ludicrous and it is incredible that anybody seriously would even contemplate such an idea. Anyway, is Nobel Prize winning economist Paul Krugman:

“It’s easy to make sententious remarks to the effect that we shouldn’t look for gimmicks, we should sit down like serious people and deal with our problems realistically. That may sound reasonable — if you’ve been living in a cave for the past four years.Given the realities of our political situation, and in particular the mixture of ruthlessness and craziness that now characterizes House Republicans, it’s just ridiculous — far more ridiculous than the notion of the coin.

So if the 14th amendment solution — simply declaring that the debt ceiling is unconstitutional — isn’t workable, go with the coin.”

Nobel Prize or not Krugman is wrong – as he so often is.

First, of all there is no reason to think that the US government would have to default on it’s public debt just because the debt ceiling is not increased. The monthly debt servicing costs in the US is significantly smaller than the US government’s total monthly tax revenues. It might be that the US Treasury would have to stop paying out salaries to US Congressmen and stop buying new military hardware for a while – neither would be a major lose – but the tax revenues would easily cover  the debt servicing costs. That of course do not mean that I suggest that the debt ceiling should not be increased – that is US party political shenanigans that I simply don’t even want to comment on. However, it is wrong to suggest that the US government would automatically default if the debt ceiling is not increased.

Lars, wouldn’t a 1 trillion dollar coin be monetary easing? So it most be good?

What I really want to discuss is the Market Monetarist perspective on this discussion. Yes, Market Monetarists have for the past four years argued that US monetary policy has been overly tight and the reason the US recovery has been so relatively weak is the that Federal Reserve has had too tight monetary policy. That has led Market Monetarists like myself and other to call for monetary easing from the Federal Reserve.

However, at the core of Market Monetarist thinking is not the call for monetary easing and no Market Monetarist has ever said that monetary easing is the cure of all evils. Rather at the centre of Market Monetarist thinking is the call for a rule based monetary policy. An easing of monetary policy based on a trillion dollar coin is probably the most discretionary and least rule based monetary (and fiscal) idea anybody have come up with over the past four years.

Yes, Market Monetarists are certainly skeptical about central bankers ability to conduct monetary policy in a proper fashion, but that certainly do not mean that we think US politicians and bureaucrats in the US Treasury would do a better job. Far from it!

I would even go further – I don’t necessarily think that the US economy needs more quantitative easing IF the Federal Reserve started conducting monetary policy based on a transparent monetary rule like NGDP level targeting. Furthermore, if I would have to chose between an NGDP level target or a massive ramping up of quantitative easing within a discretionary framework then there is no doubt that I would choose the rule based framework. Market Monetarists are not the monetary version of discretionary Krugmanian fiscal policy.

Concluding, the trillion dollar coin idea is stupid. It is stupid because it banana republic “economic” policy based on the worst political motives without any foundation in the rule of law and a general rules based framework.

The fact is that the US government faces serious fiscal challenges. The US public debt level needs to be reduced and even if the Federal Reserve pushed back NGDP to its pre-crisis trend level I believe there would be a significant need for fiscal consolidation. There is no getting around it – debt ceiling or not, trillion dollar coin or not – fiscal policy will have to be tightened sooner or later. And if you need idea about what to cut I have some ideas about that as well (see here).

It is simple mamanomics – you can’t continue spending more money than you have. It might be that certain US policy makers would be happy if their mom raised their weekly allowances, but would they also be happy if their mom prostituted herself to do that?

PS there is no party politics in what I am saying – I have the same lack of respect for both main political parties in the US as do most Americans.

PPS Scott Sumner and Tyler Cowen also comment on the trillion dollar coin – for some reason the two gentlemen are slightly more diplomatic than I am. Josh Hendrickson, however, is as clear on the issue as I am – Josh has two posts on the trillion dollar coin. See here and here.

PPPS If you think there is a lot of James Buchanan and Friedrich Hayek in this post then I have achieved what I want to achieve. After all Friedman and Schwartz’s “Monetary History” is not the only book I read.

Update: Both Steve Horwitz and George Selgin comment on the trillion dollar coin – not surprisingly I have no reason to disagree with the two gentlemen.

18 Comments
by Lars Christensen on January 8, 2013  •  Permalink
Posted in Debt ceiling, Fiscal cliff, Fiscal policy
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Posted by Lars Christensen on January 8, 2013

http://marketmonetarist.com/2013/01/08/the-trillion-dollar-coin-is-an-utterly-idiotic-idea/

The fiscal cliff has never been a market theme

When I over the last couple of days have looked at my twitter account nine of ten tweets have been about the “fiscal cliff” and the financial media all over the world have been all about that horrible “cliff”. Commentators from left to right in the US have issued warnings about the horrors of the fiscal cliff. Yes, it has felt very much like we indeed have been heading for an economic meltdown. Economic slowdown in China or the euro crisis is not important – the only thing important is the fiscal cliff (blah, blah…)

Just take a look at what Google Trends is telling us. The graph below shows searches for “fiscal cliff” over the last 90 days.

googlecliff

Since mid-November the searches for “fiscal cliff” has clearly picked up and really spiked in the last couple of weeks.

However, despite the desperate efforts of pundits and the financial media the fiscal cliff has never really become a serious market theme. The best way to illustrate this is to look at the US stock market – and more specifically on two sets of stocks – defense stocks and “consumer discretionaries”. Both sectors should be expected to be impacted heavily in the event of a full-blown fiscal cliff event as a result of tax hikes and cuts in US defend spending. I have looked the two sectors’ performance during 2012 relative to the overall stock market performance (S&P500).

If the market really had been worried about the fiscal cliff we should have seen defense stocks and consumer discretionaries plummet. However, as the graph below shows that has certainly not been the case.

fiscal cliff

In fact both consumer discretionaries and defence stocks have outperformed the overall US stock market since August-September. Therefore if anything the performance of these two sub-indices have been positively correlated with the fiscal cliff “worries”.

In fact I would argue that the markets have paid little substantial attention to the ongoing political noise from Washington. It is for example notable that defence stocks have continued to do well despite Obama’s reelection.

This of course do not prove that fiscal policy is not important – far from it, but other things are certainly much more important and the markets are a lot more forward-looking than it seems to be the “normal” perception in the financial media. The discussion of the fiscal cliff has not been (a market moving) surprise to the markets and neither has been the political “show” that we have seen in recent weeks. Yes, the US political system is dysfunctional, but that is really no surprise to the markets. Nor is it likely to be a surprise to US corporations and consumers. As consequence it hard to believe that the fiscal cliff can be classified as an “shock” to the economic system.

A the fiscal cliff as a textbook take-it-or-leave-it game

As my good friend professor Peter Kurrild-Klitgaard has noted the negotiations about the fiscal cliff has been a complete textbook example of a take-it-or-leave-it game. Even though pundits on the left and the right of US politics have bashed both the GOP and the Democrats for failing in the negotiations there is really nothing surprising about how the negotiations have played out. Any student of game theory would tell you that and apparently the markets understand game theory better than pundits and the financial media reporters.

There is no reason to play the blame game here – both the GOP and the Democrats (including the President) have so far pretty much behaved rationally (in a game theoretical sense) – that of course do not mean that what they are doing is nice to look at or for that matter in the interest of the American people, but game theorists would not be surprised – neither has the markets been.

For good discussion of the game theoretical aspects of the fiscal cliff negotiation see this excellent post by John Patty on the “The Math of Politics” blog from December 14 2012.

The real market mover is monetary policy

Finally let me just repeat the Market Monetarist position (see more previous posts on the issue here, here, here and here). Monetary policy dominates fiscal policy – the Fed will be able to counteract any negative shock to aggregate demand (or nominal GDP). The performance of consumer discretionary stocks pretty well illustrates this. As the market started to price in QE3 in August and later was positively surprised by the implicit announcement of the Bernanke-Evans rule in September consumer discretionaries have rallied. Hence, at least judging from the stock market performance monetary policy has dominated fiscal policy worries. I am not arguing that if the there had not been a “deal” on the fiscal cliff the markets would have not seen a set-back, but I am certainly arguing that this issue has gotten far to much attention compared to have relatively unimportant the issue is.

I am normally not making predictions here, but I today predict that “fiscal cliff” searches on Google has already peaked (but no I am not a betting man). From today the fiscal cliff is so much 2012. It is time to focus on something else…also for the financial media.

PS fiscal policy always have an impact of income distribution and as far and as I can see this is the real issue in the US, but that does not really make the discussion important from a macroeconomic perspective (unless it has supply side effects).

6 Comments
by Lars Christensen on January 2, 2013  •  Permalink
Posted in Bernanke-Evans rule, Evans rule, Fiscal cliff, Fiscal policy, Game Theory
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Posted by Lars Christensen on January 2, 2013

http://marketmonetarist.com/2013/01/02/the-fiscal-cliff-has-never-been-a-market-theme/

JPIrving on why not to fear the fiscal cliff

Turn on the TV and watch five minutes of CNBC or Bloomberg TV these days and you get the impression that the world is coming to an end as a result of the fiscal cliff. However, the contrast to this is the development in the US financial markets. Yes, there are some jitters in the markets, but the market developments do not exactly indicate that we falling into the abyss in a couple of days. This is the theme of a new excellent post from JPIrving.

Here is JP:

“In a situation like this, the thing to do is to look at the markets to get a sense of what they foresee. However reading markets is not so straightforward in this situation. Unlike monetary policy, which is more or less neutral in its impact on the composition of aggregate demand (where the ‘money goes first’), fiscal policy is by definition nonneutral. If the government cuts the military’s equipment budget, then military contractors stand to lose more than others.”

JP is right – if the markets really were fearing a collapse in aggregate demand then we would see a collapse in the stock markets and we haven’t seen that.

JP continues:

“If we would say that there is a 40% chance of taking on the full fiscal cliff, and that markets are already discounting this, I would say that the full fiscal cliff would not have the sort of disasterous consequences some fear. At least this is what the markets say to me.

Some regions would be hard-hit, but the recovery would survive.”

Let me just say I wholeheartedly agree.

PS Some (Johan Weissmann at The Atlantic) tells us to worry about a “Diary cliffs” as well. However, the market is not worried. I tend to believe the market, but Weissmann is right that US politicians behave as small children.

3 Comments
by Lars Christensen on December 28, 2012  •  Permalink
Posted in Fiscal cliff, Fiscal policy, JPIrving
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Posted by Lars Christensen on December 28, 2012

http://marketmonetarist.com/2012/12/28/jpirving-on-why-not-to-fear-the-fiscal-cliff/

Answering questions on “Quora” about Market Monetarism

I recently signed up for Quora. According to Wikipedia Quora “is a question-and-answer website created, edited and organized by its community of users.”

I am not a frequent user of Quora but drop by from time to time and tonight I ran into this question:

Why do some market monetarists advocate fiscal austerity?

That one I obviously had to answer and here it is:

The short answer is the Market Monetarists do not advocate fiscal austerity. What MM’ers are arguing is that monetary dominates fiscal policy. Hence, IF fiscal policy is tightened then it will not necessarily have an negative impact on aggregate demand – or nominal GDP – if the central bank for examples targets inflation or the nominal GDP level. This is known as the Sumner Critique.

The view that monetary policy dominates fiscal policy in the determination of nominal spending in the economy makes Market Monetarists less fearful fiscal austerity than for example keynesians. Furthermore, Market Monetarists are highly skeptical about discretionary policies – both monetary and fiscal – and that leads Market Montarists to advocate rule based fiscal and monetary policy.

In addition most of the leader Market Monetarists thinkers are libertarian or conservative and as such highly skeptical about a large public sector and as a result many Market Monetarists therefore would welcome cuts in public spending. That, however, is not at the core of Market Monetarist thinking.

Finally for most Market Monetarists fiscal austerity is simply about simple arithmetics – in the long run governments cannot spend more money than they bring in. Therefore, for countries that are unable to access the global capital markets – such as Greece – there is no alternative to austerity.

I have written numerous blog posts on these issues on my blog The Market Monetarist. See some of them here:

“Conditionality” is ECB’s term for the Sumner Critique

In New Zealand the Sumner Critique is official policy

Policy coordination, game theory and the Sumner Critique

The Bundesbank demonstrated the Sumner critique in 1991-92

The fiscal cliff is not the end of the world

Cato Institute on US military spending and the fiscal cliff

The fiscal cliff is good news

The fiscal cliff and the Bernanke-Evans rule in a simple static IS/LM model

The fiscal cliff and why fiscal conservatives should endorse NGDP targeting

There is no such thing as fiscal policy – and that goes for Japan as well

There is no such thing as fiscal policy

7 Comments
by Lars Christensen on December 26, 2012  •  Permalink
Posted in Fiscal cliff, Fiscal policy, Sumner Critique
Tagged , , , ,

Posted by Lars Christensen on December 26, 2012

http://marketmonetarist.com/2012/12/26/answering-questions-on-quora-about-market-monetarism/

The fiscal cliff is not the end of the world

Today is supposed to be the end of the world – at least according to classic Mayan accounts (and Hollywood?). But so far we are still here and there are not really any signs that the world really is coming to an end today. However, judging from media reports the world might be coming to an end at least in economic terms as the feared “fiscal cliff” is drawing closer after U.S. House of Representatives Speaker John Boehner yesterday failed to get support for his so-called “plan B”.

The fear is that on January 1 we will get a massive US fiscal tightening unless a compromise to avoid it is reached. However, as I earlier have argued the fiscal cliff might not be as bad as it commonly is said to be. The fact is that no matter what US policy makers will have to tighten fiscal policy in the coming years as the size of the budget deficit clearly is unsustainable. Hence, it is just really a timing issue about when fiscal policy will have to be tightened. Fiscal tightening is unavoidable.

The Permanent Income Hypothesis and the Sumner Critique
- two reasons why the fiscal cliff is not the end of the world

Said in another way whether or not there is a compromise made on the fiscal cliff or not – this time around – it will have no impact on the average American’s Permanent Income. Hence, the average American will have to pay for the US budget deficit in some way or another today or tomorrow. There is really no way around it.

In his brilliant book “A Theory of the Consumption Function” Milton Friedman distinguished between permanent and transitory changes in income and he argued – contrary to the prevailing Keynesian dogma at the time – that only permanent changes in income would have an impact on private consumption.

This also means that if tax payers are given a tax break today, but are told that they will have to pay it all back in the form of higher taxes tomorrow then it will have no impact on private consumption today as the income increase is only transitory and will have no impact on the tax payers’ permanent income.

This would obviously also mean that if US tax rates are indeed increased in 2013 and that the revenue is used to reduce the US budget deficit then that will have no negative impact on the US tax payers’ permanent income as higher taxes today basically just mean that taxes will not have to be increased in the future.  This result of course is a variation of the so-called Ricardian Equivalence Theorem as formulated by Robert Barro in his classic article “Are government bonds net wealth?” from 1974.

Hence, if you believe in the fundamental truth of Friedman’s Permanent Income Hypothesis then you would expect the impact of a tax increase to cut the budget deficit and public debt to be much smaller than what the paleo-Keynesian textbook models would indicate.

One can of course debate whether the Permanent Income Hypothesis is correct or not and discuss especially the empirical validity of the Ricardian Equivalence Theorem (RET). Personally I am somewhat skeptical about assuming that RET will always hold.

However, on the other hand if the budget deficit is not reduced then sooner or later I certainly would expect some kind of RET style effect to kick in. That would naturally trigger consumers to cut spending on the expectation of higher taxes. The budget deficit will have to be cut – either through higher taxes or lower public spending - whether or not the fiscal cliff (if it happens).

I am not arguing that tax increases are good – certainly not. I think higher taxes have significantly negative supply side effects but I am very skeptical about the view that private consumption automatically will drop as much as the increase in taxes and even more skeptical that that would have an impact on aggregate demand (more on that below).

This discussion is similar to the discussion in a new paper by Matt Mitchell and Andrea Castillo. In their paper “What went wrong with the Bush tax cuts?” they discuss why the Bush tax cuts failed to spur growth.

I must admit I have not fully digested the paper yet (it just came out), but as I read it Mitchell and Castillo argue that the 2001 Bush tax cuts failed to have the intended economic impact primarily for two reasons. First, the tax cuts were announced to be temporary – and hence Milton Friedman would have told you that it would have no impact on permanent income and hence no impact on private consumption. Second, Mitchell and Castillo argue that since the tax cuts were not accompanied by similar budget cuts then consumers and investors would not expect the tax cuts to last – even if politicians had claimed they would.

I believe that if one argues that the Bush tax cuts failed to boost private consumption growth because of the reasons discussed above then you would have to think that there will be little impact on private consumption when the tax cuts expire. Again I am not talking about supply side effects, but the expected impact on private consumption and aggregate demand.

Aggregate demand is determined by monetary policy and not by fiscal policy

Even if the fiscal cliff would be a negative shock to private consumption and public spending it is certainly not given that that would lead to a drop in overall aggregate demand. As I have discussed in earlier posts if the central bank targets NGDP or inflation for that matter then the central bank tries to counteract any negative demand shock (for example a fiscal tightening) by a similarly sized monetary expansion.

Even if we assume that we are in a textbook style IS/LM world with sticky prices and where the money demand is interest rate sensitive the budget multiplier will be zero if the central bank follows a rule to stabilize aggregate demand/NGDP.

As I have shown in an earlier post the LM curve becomes vertical if the monetary policy rule targets a certain level of unemployment or aggregate demand. This is exactly what the Bernanke-Evans rule implies. Effectively that means that if the fiscal cliff were to push up unemployment then the Fed would simply step up quantitative easing to force back down unemployment again.

Obviously the Fed’s actual conduct of monetary policy is much less “automatic” and rule-following than I here imply, but it is pretty certain that a 3, 4 or 5% of GDP tightening of fiscal policy in the US would trigger a very strong counter-reaction from the Federal Reserve and I strongly believe that the Fed would be able to counteract any negative shock to aggregate demand by easing monetary policy. This of course is the so-called Sumner Critique.

The fiscal cliff is not going to be fun
…but it will certainly not be the end of the world

I am not arguing here that the fiscal cliff would be without problems. While the US certainly needs consolidation of public finances there are likely only small costs of postponing the fiscal adjustment and the uncertainty about the US tax code is certainly not good news from a supply side perspective. However, from a aggregate demand perspective I think there is much less reason to be worried than debate in the US would indicate.

Relax the world is not coming to an end…yet.

PS I admit that judging from the market action today we have to conclude that investors are likely not as relaxed about the fiscal cliff as I am. As a faithful Market Monetarist that leaves me with a bit of a dilemma – should I trust my own economic reasoning or should I trust the signals from the markets?

PPS this guy – my friend Martin – is well-prepared for an alien invasion (he is completely unprepared for the fiscal cliff)

MOH

9 Comments
by Lars Christensen on December 21, 2012  •  Permalink
Posted in Evans rule, Fiscal cliff
Tagged , ,

Posted by Lars Christensen on December 21, 2012

http://marketmonetarist.com/2012/12/21/the-fiscal-cliff-is-not-the-end-of-the-world/

Duncan and Coyne on “The Overlooked Costs of the Permanent War Economy”

I hope my loyal readers will forgive me for going a bit overboard on the fact that I think cuts in US defense spending will do the US economy well, but you have to read Thomas K. Duncan and Christopher J. Coyne’s new paper on “The Overlooked Costs of the Permanent War Economy”. Here is the abstract:

How does the permanent war economy interact, and subsume, the private, non-military economy? Can the two remain at a distance while sharing resource pools? This paper argues that they cannot. Once the U.S. embarked upon the path of permanent war, starting with World War II, the result was a permanent war economy. The permanent war economy continuously draws resources into the military sector at the expense of the private economy, even in times of peace. We explore the overlooked costs of this process. The permanent war economy does not just transfer resources from the private economy, but also distorts and undermines the market process which is ultimately responsible for improvements in standards of living.

Just have a look at this excellent paper and then I will shut up about this issue – for now at least.

3 Comments
by Lars Christensen on December 3, 2012  •  Permalink
Posted in Chris Coyne, Fiscal cliff, Thomas Duncan
Tagged , ,

Posted by Lars Christensen on December 3, 2012

http://marketmonetarist.com/2012/12/03/duncan-and-coyne-on-the-overlooked-costs-of-the-permanent-war-economy/

Cato Institute on US military spending and the fiscal cliff

In an earlier post I claimed that the “full” fiscal cliff would not necessarily be a disaster for the US economy – and I was probably also unusual forthcoming in my hope that US defending might be cut as a result of the fiscal cliff, but this blog is primarily about monetary policy issues so I don’t want to bore my readers with more of my views on the US defense budget. Instead I would like to recommend my readers to have a look at what the Cato Institute has to say on this issue.

This is from Cato Institute’s Facebook page:

In recent days several senior Republicans have come out saying they would be willing to break their anti-tax pledge as part of the fiscal cliff negotiations. At least one of those lawmakers, Senator Lindsey Graham, has said that this is because he is unwilling to let sequester budget cuts “destroy the United States military.” Cato scholars have long argued that the proposed sequester cuts would allow the United States to maintain a wide margin of military superiority, while paying substantial dividends for the U.S. economy over the long run.

• “Budget Hawks or Military Hawks?,” Cato Video with Grover Norquist - http://youtu.be/C7AWXLDPmE0

• “The Bottom Line on Sequestration,” by Christopher Preble -http://www.cato.org/publications/commentary/bottom-line-sequestration

• “The Pentagon Will Survive the Fiscal Cliff,” by Justin Logan -http://www.cato.org/publications/commentary/pentagon-will-survive-fiscal-cliff

Enjoy and stop worrying about lower public expenditures – after all the Sumner Critique applies: NGDP will be unaffected by lower defense spending as long as the Federal Reserve implements the Bernanke-Evans rule. By the way fiscal conservatives should be impressed with this – if the Fed keeps NGDP on track (or follow a Bernanke-Evans style policy rule) then it will remove any keynesian style opposition to fiscal consolidation.

You might also want to have a look at this excellent article by Gallaway and Vedder on the “The Great Depression of 1946″. There was of course no Great Depression in 1946 despite a massive cut in US military spending by the end of the Second World War. It is not everything Gallaway and Vedder write that I agree on, but I nonetheless think that they make a very compelling case that even drastic cuts in defense spending is unlikely to lead to any serious economic downturn. That was the case in 1946 and would be the case in 2013.

By the way Cliff is not worried…

Cliff-Clavin-Forget-the-Fiscal-Cliff-CNBC

11 Comments
by Lars Christensen on December 2, 2012  •  Permalink
Posted in Cato, Fiscal cliff, Fiscal policy, Lowell Gallaway, Richard Vedder
Tagged , , , ,

Posted by Lars Christensen on December 2, 2012

http://marketmonetarist.com/2012/12/02/cato-institute-on-us-military-spending-and-the-fiscal-cliff/

The fiscal cliff is good news

When I started this blog I set out to write about monetary policy issues – primarily from a none-US perspective – and furthermore I am on vacation with my family in Malaysia so writing this blog post goes against everything I should do – however, after listen to five minutes of debate about the ”fiscal cliff” on CNBC tonight I simply have to write this: What is your problem? Why are you so scared about fiscal consolidation? After all this is what the fiscal cliff is – a 4-5% improvement of public finances as share of GDP.

The point is that the US government is running clearly excessive public deficits and the public debt has grown far too large so isn’t fiscal tightening exactly what you need? I think it is and the fiscal cliff ensures that. Yes, I agree tax hikes are unfortunate from a supply side perspective, but cool down a bit – it is going to have only a marginally negative impact on the long-term US growth perspective that the Bush tax cuts expiries. But more importantly the fiscal cliff would mean cuts in US defense spending. The US is spending more on military hardware than any other country in the world. It seems to me that US policy makers have not realized that the Cold War is over. You don’t need to spend 5% of GDP on bombs. In fact I believe that if the entire 4-5% fiscal consolidation were done, as cuts to US defense spending the world would probably be a better place. But that is not my choice – and it is the peace-loving libertarian rather than the economist speaking (here is a humorous take on the sad story of war). What I am saying is that the world is not coming to an end if the US defense budget is cut marginally. Paradoxically US conservatives this time around are against budget consolidation. Sad – but true.

Since September the Federal Reserve has had the Bernanke-Evans rule in place. That means basically means that the Fed will step up monetary easing in response to any increase in unemployment. Hence, if the full fiscal cliff leads to any increase in unemployment the fed will counteract that with monetary easing. So effectively the fiscal cliff means fiscal tightening and monetary easing. This of course would also be the case if the fed was a strict inflation targeting central bank – that directly follows from the Sumner critique.

Fiscal consolidation and monetary easing is this is exactly what the US had in 1990s – the best period for the US economy since WWII. By at that time a Democrat President also had to work with a Republican dominated Congress.

So no, I don’t understand what there is to fear. Lower public spending and easier monetary policy is the right medine for the US economy (yes and please throw in some structural reforms as well). If that is the fiscal cliff please bring it on. It will be good for America and good for the world. And it might even be a more peaceful world.

—-

PS if you are really concerned about the fiscal cliff just agree on this:

1) Cut US defense spending to 2% of GDP

2) NO tax hikes

3) Commit the fed to bring back NGDP to the pre-crisis trend level through QE

Update: My version (second and third!) version of this post had an incredible amount of typos – sorry for that. I have now cleaned it up a bit.

Update 2: David Glasner also comments on the fiscal issue – David agrees with me in theory, but is more worried about the what the fed will do in the real world. When David is saying something I always listen. David is a real voice of reason – often also of moderation. That said, I strongly believe the Sumner Critique is correct. NGDP is determined by monetary policy and not by fiscal policy – so if the fiscal cliff will lead to a recession the fed will be to blame and not the US politicians (they are to blame for a lot of other things…).

21 Comments
by Lars Christensen on November 16, 2012  •  Permalink
Posted in David Glasner, Fiscal cliff, Fiscal policy, Sumner Critique
Tagged , ,

Posted by Lars Christensen on November 16, 2012

http://marketmonetarist.com/2012/11/16/the-fiscal-cliff-is-good-news/

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