Category: Equitablog

**Paul Krugman**: Crowding In and the Paradox of Thrift: “Francesco Saraceno notes… IMF… research… has become an extraordinary source of information and ideas…

…Chapter 4, on business investment… weak… [because of] a special problem of lack of business confidence, driven by fiscal worries, failure to make needed structural reforms, and maybe even careless rhetoric… [or] weak because the economy is weak[?]… The IMF comes down strongly for the second view….

But wait, there’s more…. To deal with… reverse causation… it looks for episodes of weak growth… clearly caused by… fiscal consolidation… [and] manages in passing both to refute a very widely held but false belief… that government deficits necessarily ‘crowd out’ investment, so that reducing deficits should free up funds that lead to higher investment. Not so, says the IMF: when governments introduce deficit-reduction measures, investment falls instead of rising. This says that the deficits were crowding investment in, not out… empirical confirmation of the existence of the paradox of thrift! Remarkable stuff. Someone tell Wolfgang Schäuble.

…is leaving red states poorer and sicker…. King v. Burwell…. If the Supreme Court rules for the plaintiffs, those states, including Arizona, will lose their subsidies. That would be a disaster for those states. As Sarah Kliff writes:

Approximately 205,000 Arizonans are receiving coverage through the marketplace. Of those, 76 percent are receiving subsidies to help cover the cost of their premiums. An adverse ruling would likely lead the state’s exchange to collapse, as healthy, young Arizonans who could only afford insurance because of the subsidies pull out and the exchange itself enters into a death spiral.

What Arizona has promised to do is let that happen… a decision made, of course, by legislators and a governor who have insurance now, and will have it in the event of an adverse Supreme Court ruling….

If the subsidies are ripped out of federal exchanges, it will only cripple the law in red states that loathe the legislation. Obamacare will work fine in states that want it to work; those states either have their own exchanges now or they’ll quickly build them. But resistant red states will be left with a wrecked insurance market–and a hefty tax bill…. Republicans in those states will still be paying the taxes and bearing the spending cuts needed to fund Obamacare. They just won’t be getting anything back.
In effect, the Republican plan to destroy Obamacare has become a plan in which red states subsidize Obamacare in blue states….

More than 20 Republican-led states have rejected the Medicaid expansion. The result is about 5 million more Americans without insurance… [and] those states are forgoing about $37 billion in federal funds in 2016 alone…. Republicans warned that Obamacare would wreck health insurance markets, do little to help the uninsured, and leave everyone else paying hefty taxes to fund a rolling disaster. In fact, Obamacare has covered millions of people at a much lower cost than expected. But as a byproduct of their tactics against Obamacare, Republicans are making their predictions come true, at least for their own residents.

After accounting for the multiplier, the absence of the Medicaid expansion and other ObamaCare nullification efforts is putting a downward drag on economic growth in Red States of about 0.5% this year: a 2%-point growth in the non-insurance gap times 1/6 of the economy times a 1/2 insurance-spending attenuation factor times a Keynesian multiplier of 3:

Add to that the effect of the oil price declines like 1986 and 1998 on the oil patch:

And I do not see how the Dallas Fed can still forecast:

This year Texas job growth likely to moderate to 2.0-2.5%, about 259,000 jobs–149,000 fewer than 2014–and close to US job growth… 


In particular, we discuss the emergence of a deflationary safety trap equilibrium which is an acute form of a liquidity trap. In this context, issuing public debt, swapping private risky assets for public debt, or increasing the inflation target, stimulate aggregate demand and output, while forward guidance is ineffective. The safety trap can be arbitrarily persistent, as in the secular stagnation hypothesis, despite the existence of infinitely lived assets. When we endogenize the private securitization capacity, we show that in a safety trap there is a securitization externality that leads to underprovision of safe assets.

…The authorities did not recognise the stroke… thought it was simply a particularly nasty cold… put extra whisky in the hot toddies…. Just as the patient was beginning to show signs of improvement, it experienced a second stroke. This one was not as catastrophic as the first, but it seriously set back the patient’s recovery. Once again, the stroke was misdiagnosed, this time as a hospital-acquired infection…. Now, seven years after the first stroke and three years after the second, the patient is still partly paralysed down the left side and has a speech impediment….

Herein lies my beef with Blanchard. Hot toddies and antibiotics are not the right treatment for strokes. Nor is deep cleaning of hospitals, important though this is. But the economics profession’s toolkit seems to be limited to hot toddies, antibiotics and cleaning ladies…. And it justifies its limited diagnostic skills and inadequate toolkit by arguing that if only we keep warm and dry and eat well, we won’t catch colds or suffer strokes anyway…. I confess I find it difficult to see how a system that is normally far from equilibrium can be adequately represented by a general equilibrium model, but then I am not a mathematician. I am encouraged therefore to see that Borio seems to share my concerns (my emphasis):

Modelling the financial cycle raises major analytical challenges for prevailing paradigms. It calls for booms that do not just precede but generate subsequent busts, for the explicit treatment of disequilibrium debt and capital stock overhangs during the busts, and for a clear distinction between non-inflationary and sustainable output, ie, a richer notion of potential output–all features outside the mainstream….
 
So, sorry Brad, but I do not think I am wrong to say that the economics profession’s love affair with linear models must be ended. Multiple equilibria, disequilibrium and non-linearities are the new flame. Having said that, Brad’s last comment is spot on:

The key questions of macroeconomic political economy then are not the questions of the construction of nonlinear multiple-equilibrium models that Frances Coppola wants us to study. They are, instead, the questions of why ideological and rent-seeking capture were so complete that North Atlantic governments have not deployed their fiscal and credit policy tools properly since 2008.

Indeed, if policymakers want to deny stroke patients essential treatment and force them back to work before they are properly recovered, there is not a great deal economists can do to stop them. Such is democracy….

Despite my criticisms, Olivier Blanchard deserves credit for acknowledging the hubris of the 1980-2008 economic paradigm, and for attempting to change it within his own organisation. Some of the IMF’s economic research in recent years under his leadership has been outstanding. He is indeed a vir illustris.

…The constraints on fiscal policy are determined by two factors: 1) can you print your own money, and 2) is unemployment already so low that fiscal stimulus is inflationary…. One of the things I dislike about the unthinking obsession with “expectations” in today’s monetary policy discourse is the suggestion that “inflation expectations” can suddenly–out of nowhere–go haywire. This a bit like the idea of bond panic. One day–for some unknown reason–the bond market is going to think that the government won’t raise future taxes, and panic…. But if the central bank can do QE, there cannot be sustained bond panic in the absence of a genuine inflation problem. Why? Because, as the BoJ is showing, faced with no inflation risk, the central bank can buy all the bonds.

All that matters then is what causes a sustained rise in inflation. The idea that the population wakes up one day and decides that because the national debt has gone through the Reinhart and Rogoff limit, or because a check from the Fed has arrived in the post, there is going to be a wild outbreak of inflation, is unconvincing…