DeLong, "Fiscal Policy in the Second Half of 2009" (June 6, 2009) by James DeLong

Fiscal Policy in the Second Half of 2009

6/17/09 9:10 PM

Grasping Reality with Both Hands The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, Reality-Based, and More than Two-Handed Look at the World J. Bradford DeLong, Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.

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Fiscal Policy in the Second Half of 2009 A DRAFT of a letter I might send next week: Dear President Obama-At the end of 2008, when your incoming administration was preparing your recession-fighting strategy, your forecasts were that the recession would bottom out in August of 2009, with a peak unemployment rate of 7.9%. The unemployment rate in May was already 9.4%. 10% unemployment this year is a nearly foregone conclusion. 11% unemployment--a recession twice as deep http://delong.typepad.com/sdj/2009/06/fiscal-policy-in-the-second-half-of-2009.html

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already 9.4%. 10% unemployment this year is a nearly foregone conclusion. 11% unemployment--a recession twice as deep as the one your incoming administration was forecasting at the end of 2008--is not unlikely. An 11% unemployment rate would carry along with it an underemployment rate--a U-6--that would kiss 20%. Even had the fiscal expansion plans of your administration not been cut back by roughly a quarter in their employmentgenerating effectiveness by the Congress, fiscal stimulus plans that appeared to be adequate and appropriate at the turn of the year now appear to be inadequate. Compounding the problem of inadequate fiscal expansion at the federal level is the problem of inappropriate and substantial fiscal contraction at the state level. Last fall Nobel Prize-winning Princeton economist Paul Krugman feared "fifty Herbert Hoovers"--fifty states each trying to balance its budget year-by-year and each one delivering a substantial drag on employment and income in its and its neighbors' economies. I therefore believe: That it is past time for you to seek from the Congress for authority to guarantee the debt of states that, in response to the current recession, (a) seek to conduct their own state-level fiscal expansions, and (b) devise plans and strategies for the long-term repayment of the debt the federal government guarantees that the Secretary of the Treasury certifies as prudent and sustainable. That it is time for you to seek from the Congress an amended Budget Resolution: to include in this year's forthcoming Reconciliation process an additional $500 billion of federal aid to states, distributed per capita and conditioned on their maintaining effort at the provision of public services--on their not repeating the mistake of Herbert Hoover of cutting government employment and spending in a downturn. Sincerely yours, J. Bradford DeLong RECOMMENDED (5.0) by ,13 people like you [How? ] You might like:

DeLong: A Wall Street Fairy Tale (@this site) Hoisted from the Archives (July 15, 2007): Caccianli i Ciel per Non Esser Men Belli,/ N lo Profondo Inferno Li Riceve... (@this site) 2 more recommended posts Âť Brad DeLong on June 06, 2009 at 09:21 AM in Economics: Fiscal Policy | Permalink Comments Barney Frank is already drafting legislation to offer federal guarantees for state and local debt, no? Maybe you should mention that in your letter... Posted by: lemuel pitkin | June 06, 2009 at 09:41 AM You're trying to repeal the political law of gravity. Governors already have problems getting re-elected in tough times under the status quo. There's absolutely no percentage in their signing deficit-running budgets, whether the debt they entail is guaranteed or not by the Fed. We've gotten all the stimulus we're going to get, federal and state, and as a practical matter, the oil-price rollback that was the biggest stimulus of all is over. Basically, we're doomed. I don't expect to ever see a U6 of less than 15% again in my lifetime, and I'm 52. The 'governments should be run like families, paying all their bills every month' trope is too deeply entrenched to be overcome. Some ideas are more durable than even the collapse of the structures that generate them, and that they explain. http://delong.typepad.com/sdj/2009/06/fiscal-policy-in-the-second-half-of-2009.html

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ideas are more durable than even the collapse of the structures that generate them, and that they explain. People faced with a stark choice of their prejudices, or reality, will choose their prejudices every time. Posted by: Davis X. Machina | June 06, 2009 at 10:25 AM Many state Constitutions prohibit deficit spending, and unlike the feds the states actually have to use honest accounting methods. The states could use bond issues to fund capital construction, but none (or little) of the money could be used for current operating. So probably the only way to help states would be to pour money directly into their general funds. States are cutting operating budgets because they have to, and taxpayers are not likely to have warm thoughts about tax increases (while Michigan collapses some politicians in the Granholm administration are asking for tax increases, rather than ruffle union feathers. The reaction was not too warm - Granholm recently engineered a deal with the big utilities guaranteeing rate increases. Posted by: save_the_rustbelt | June 06, 2009 at 10:38 AM "..administration not been cut back by roughly a quarter in their employment-generating effectiveness by the Congress" It wasn't Congress, it was the economy computing multipliers and getting numbers less than one. The only way to keep short term rates at zero and find economies of scale is to reduce state and federal government spending. The money Barney want to allocate from the federal budget to the state budget will do exactly that, be used to pay off past bad bets and reduce future bets. The long term rates rises that state governments see are telling the politicians one thing, reduce future commitments. Expanding the fiscal balance sheet to cover this process spreads the pain of adjustment, but otherwise fails to solve the original constraint that got us into the downturn. The more time spent paying off past bets is less time spent solving the original constraint. Posted by: Mattyoung | June 06, 2009 at 10:41 AM You forgot to offer your support to raise the Federal Debt Limit, which was just raised in February. Posted by: pebird | June 06, 2009 at 12:02 PM Some states will turn down the money. Why give $ to all 50 states when it's CA that is going to need the special bailout? Why should I in VA have to be paying YOUR taxes?? Pay 'em yourself. Posted by: tjallen | June 06, 2009 at 02:03 PM "That it is past time for you to seek from the Congress for authority to guarantee the debt of states" Right. Because that won't cause any moral hazard... "That it is time for you to seek from the Congress an amended Budget Resolution: to include in this year's forthcoming Reconciliation process an additional $500 billion of federal aid to states..." Brad DeLong, I have heard you argue previously (and I'm paraphrasing) that a larger stimulus package is nothing to worry about because Treasury borrowing costs remained low. Has the recent upward movement in yields changed your opinion on this at all? If not, at what point would it? Posted by: Dave | June 06, 2009 at 03:09 PM But the government doesn't have any money. All it has are debts. All that will do is move around debt from one place to another. What is required is capital. Sell off a few warships, disband the army, pull the troops out of foreign lands, stop sending money to Israel, and shut down the Nuclear bomb factories. Posted by: Eric Blood Axe | June 06, 2009 at 03:34 PM Michigan shuts 8 prisons to save $120M The state, which has been hammered by the auto industry meltdown, estimates that it will save $120 million by shuttering the eight facilities. None of the 4,149 prisoners in the facilities will be released early, but up to 1,000 workers may lose their jobs. http://delong.typepad.com/sdj/2009/06/fiscal-policy-in-the-second-half-of-2009.html

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facilities. None of the 4,149 prisoners in the facilities will be released early, but up to 1,000 workers may lose their jobs. The Wolverine State is targeting the correctional system because it takes up 22% of the state's general fund budget, the largest component. The state must close the $1.4 billion gap before its fiscal year ends on Sept. 30. With tax revenues coming in below estimates, Gov. Jennifer Granholm last month was forced to slash spending by $350 million, including a 4% across-the-board reduction. The move comes after the governor cut $134 million from the budget in December. The cuts made in May mean adults on Medicaid are losing dental and vision coverage. New state trooper graduates are losing their jobs, and local communities are losing 1/3 of their remaining state revenue-sharing funds. Posted by: bakho | June 06, 2009 at 04:25 PM At a policy level the suggestion of another stimulus makes a lot of sense. In terms of the short-term political calculus though, I wouldn't be surprised to see some push-back from legislators. If they're thinking in a two year increment though, perhaps they'll see the wisdom of the move too from a political standpoint. Most voters will care about the economic recovery first -- and measure the recovery from their own situation. The added debt would have to be dealt with later. Posted by: Jim | June 06, 2009 at 05:33 PM The case you argue is a good one, but I wonder how we should think of states, in general and specifically. The CA government is in a pickle and (for somewhat understandable reasons) was recently denied the authority to simply begin to right their budget by referendum. The result will, apparently, be severe cuts to services. In normal times, my sentiment runs toward 'Fine, if you don't want to fund the social services, you should learn to do without them.' But these aren't normal times. The state government has a responsibility to prudently manage its affairs - I'm not sure anyone is convinced CA (among other states) has been doing that. Flip side, state governments can't be allowed to default and the ongoing service cuts are nearly as undesirable. Politically, the appearance of 'bailing out' CA or MI (etc) is, I suspect, even more unpopular than the financial bailouts. I would consider amending your proposals. I don't know if Congress would go for assuming / guaranteeing state debt - not without extracting some concession (what?). Instead, what about no / low interest loans payable over some lengthy period, possibly combined with some stipulations on how it is to be payed back either on the revenue side (clean energy policies?) or forgiveness conditions tied to meeting socially desired targets (% schooled, insured; who knows). Posted by: tegwar | June 06, 2009 at 06:28 PM OK, Brad, I can't disagree with the argument that states desperately need money, and, in some cases, that's just to maintain basic services. In the midst of the crisis, we can argue that throwing money at states will keep the most needy (as well as many formerly well-to-do people) from falling through the social services cracks. I don't have a problem with that, short term, at least. But I would like to see future federal subsidies go to both immediate human needs and projects that produce tangible gains. How about a revival of the old 1930's art deco federal buildings? Perhaps another Golden Gate Bridge? Posted by: Samdog | June 06, 2009 at 07:45 PM There are some political options for dealing with states that refuse stimulus money. For example, include a provision to have the refused money split among the neighboring states. That way a refusing state's people can watch the stories of neighboring states spending their bonus money. And on an economic note, the money will stay nearby. Posted by: Jim Lund | June 06, 2009 at 09:35 PM Good analysis and sound recommendations but a political non-starter. Those who turned a structural budget surplus projected to have wiped out the entire federal debt by now into an enormous structural deficit of $1.0tn p.a. that is now recession-magnified to $1.5tn p.a. too bitterly oppose the effects of their own tax cuts to allow even a very popular president to run requiisite antirecessionary deficits. Posted by: d4winds | June 07, 2009 at 02:25 AM The most direct way to help states is to send money through dedicated Medicaid and food stamp programs. Trying to prop up government jobs and benefits is a non-starter, it would allow state politicians to get their hands on the money, and we already know how that works. Posted by: save_the_rustbelt | June 07, 2009 at 07:33 AM http://delong.typepad.com/sdj/2009/06/fiscal-policy-in-the-second-half-of-2009.html

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This would be a good time to blog about fiscal unions, Brad. In particular, a discussion of fiscal unions that appear to be handling the problem well (in contrast to the US or EU) would be timely. (I can't think of any to hold up as good examples right now though.) Posted by: Simon van Norden | June 07, 2009 at 07:35 AM All this effort to get things back like they were, so we can pick up where we left off, and keep doing what we did before... Is that what we want? Is it even possible? I think we need to redefine "normal" economic activity (or it will be redefined for us anyway). I do not believe our goal ought to be the same economic system we thought was normal before. It crashed. Why do we want to go there again? It's broke, and we need a new way forward. What I think we especially do not need, is loans to get us back where we were. Then we'll be back where we started, but with big big loans to pay on top of normal economic circumstances. If what went on before was bad, imagine what it will be like with big loans to pay, lurking in the background. Instead, I think there will be a big redefinition of 'normal' economic activity, with the middle and lower class much poorer, and the normal idea of the consumer driving the economy, that component will be much, much smaller. Look at the economy of countries that have no middle class, and that's more like what normal will be in the US future. And I think that kind of economy will not support the go go economy where the elites live off of the middle class's labor, like what went on before. Posted by: tjallen | June 07, 2009 at 10:36 AM Suppose we compare wealth accumulated by labor and wealth accumulated by redeployment of capital. It is the latter that, in my opinion, has been out of whack since the '80s. Investors as a class began demanding higher and higher rates for their capital, and many long-established businesses that paid a solid 6% year in and year out could not go forward, because investors wanted more, 8%, 10% and more. So there businesses either went out of business or found artificial ways of generating the needed income for their investors. Also, investors invested in riskier and riskier situations, to get the amount they 'demanded' for their capital. So no surprise, all the solid businesses that formed a foundation for the economy disappeared, leaving only those that could pay the investor more and more, either by artificial means or by being riskier ventures. And investors demanded more (in their greed) 15%, 18% and envy of those making 20% made them ask for more, more, more,... no surprise it all crashed! What I see happening in a re-adjustment is not the laborers who have to give up pay, it is the investors who will have to give way, and change their expectations on how much their capital is worth. Hint: less. Lots less. Posted by: tjallen | June 07, 2009 at 11:09 AM And, as the hand was tipped by that Reason article, the problem goes much deeper. The USA is losing its middle class. Why? Because there is no work for the middle class. Why is there no work for the middle class? The answer is revealed by a trip to Target. The people who needed the bailing out will not be bailed out. The people who shouldn't have been bailed out, were---with the firm support of this blog. Posted by: Mandos | June 07, 2009 at 01:58 PM This might be tricky. An overview of state budgetary woes is here, courtesy of the Center on Budget and Policy Priorities: http://www.cbpp.org/cms/index.cfm?fa=view&id=711 The average 2010 budget shortfall for the 45 states with current problems is 19% of the 2009 general fund. But the standard deviation isn't small (8%) and the distribution has skew - meaning there are a few states with really bad numbers. Unfortunately, the largest states have the poorest numbers. California faces a 2010 shortfall of 34%, NY's is 29%, Illinois: 25%, Florida: 23%. Then again, we could probably afford to cut checks for $60 billion to the states this year and $130 billion in 2010: this would cover the shortfalls. If the grants are proportionate to population, excess funds would be enjoyed by ~38 states, while ~13 would remain in the hole. (I need to check my numbers though.) I'm not sure how the politics of that would play out. I trust that instances of waste, fraud and abuse would be trumpeted. If state constitutions permit federal loans as in DeLong's proposal, then the situation becomes more difficult to understand.

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Posted by: Measure for Measure | June 07, 2009 at 02:29 PM What can you say ... Nice try? Since our future solvency comes out of holes in the ground it is going to be hard to repay rapidly expanding future obligations out of less. And less and less and less ... Since you have the President's ear, it would be better if you asked him to not prop up the sagging state governments, who believed that sprawl- related growth would go on forever. Better to let some state figure out how to match expenditures with (declining) revenues. Trying to preserve the status quo is futile. You should avoid the common error of believing that this recession is of short duration like all of our other recession/depressions. The 1930's depression only lasted ten years. What is happening now is a permanent re- alignment or paradigm shift. There is less energy available now than ten years ago. There will be less at the end of this year. In five years it will be shocking how much less energy will be available, regardless of price. This is not simply a US problem or a developed- world problem, it is a human race problem. You can use your imagination to figure out how things will be with substantially less oil and an 'energy tax' that makes all business prohibitively expensive. Give my regards to the President. Posted by: steve from virginia | June 07, 2009 at 04:30 PM I see dead greenshoots. Posted by: Paul Volkser | June 07, 2009 at 09:07 PM The problem with this philosophy is that people don't want to go back to the way things were. Both my parents are part of the U6 and they are very unwilling to go back to being fully employed. Combined between them they lost about 80K in income and they are enjoying their lives much more. Posted by: transgenmom | June 08, 2009 at 03:58 AM And so, a few weeks after the wishful mantra of "green shoots" became widespread, the administration will move toward a second stimulus package? Hard to imagine. What is it about this crisis and our leadership that makes it so difficult for them to see how devastating this really is? Too many years at the top of the heap? American exceptionalism? And we still wonder how Japan has remained in a trough after all of these years. Posted by: Neal | June 08, 2009 at 05:51 AM On the other hand... Calvin Coolidge cut budgets significantly ("slashed" is not an exaggeration) during the 1920-1921 downturn, and things turned out fine. In fact, they turned around much faster than when FDR tried to do his New Deal stimulus. Posted by: Lucas M. Engelhardt | June 08, 2009 at 06:34 AM The admin is trying to sneak another bank bailout by in the war supplemental and you expect them to openly try another stimulus? Three problems: China won't lend them the money to do that, they can't get it anywhere else (having blown trillions on the banks), and just trying it will blow the green shoots cheerleading to smithereens. Posted by: TJ | June 08, 2009 at 06:52 AM transgenmom made a very interesting and neglected point. Many of us, me included, are much happier having less money and no job. A lot of jobs involve such high transaction costs they a true accounting makes them unworkable. Posted by: Mattyoung | June 08, 2009 at 07:22 AM As far as I know, U-6 is a measure of underemployment which counts people who want to work more hours if they were available; I don't think any of the measures regard voluntary underemployment as underemployment. http://delong.typepad.com/sdj/2009/06/fiscal-policy-in-the-second-half-of-2009.html

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Posted by: Tom Womack | June 08, 2009 at 09:50 AM Hey, TJAllen- California has been the number 1 tax donor state for some time now. Virginia is the number 2 tax recipient state. This means WE have been paying YOUR taxes for some time now. You couldn't have chosen a weaker argument, actually. In a sense, all California is asking for is that states like Virginia stop freeloading for a few years so we don't have to feed you our childrens' lives. But, now that your golden goose lies prostrate before you, you'd love to see it gutted. Awesome. Posted by: Jon | June 08, 2009 at 10:25 AM Is there any way that this can happen politically? There is no way that the admin can be seen to be favoring some states over others, no way a democratic president can rescue democratic state governments. This will cost an amazing amount of political capital, and there are so many other things on the plate. Republican governors must lead the way here. They can spend their political capital in Washington and come out looking like heroes at home (if they play it right). Schwarzenagger (CA 33% gap), Gibbons (NV 31%), Crist (FL 22%), Jindahl (LA 22%), Rell (CT, 23%), Pawlenty (MN 18%),Perdue (GA 15%). Huge deficits, huge cutbacks but Good luck getting them to ask the Fed for money! Democratic governors must also go to Washington, but they are less important politically. If they ask for money, their Republican political careers are over (or so it would seem). If they don't ask for money, could they possibly have a political future? Posted by: PPageMcCaw | June 08, 2009 at 10:51 AM

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