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Policy Hub: Macroblog provides concise commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues for a broad audience.

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February 6, 2007

Just A Thought

This, from John Irons, seems to sum up the general reaction to the President's 2008 budget proposal:

According to news.google.com, there are currently 306 stories on: “dead on arrival” bush budget

Am I the only one finding this sort of reaction increasingly wearisome?  I'm all for critical analysis -- I like to think that that is what macroblog is all about.  But maybe if we start insisting that the first thing out of the ever-moving mouths of pundits and lawmakers alike is about what is doable rather than what is not, we might actually some day make some progress.

As I said, just a thought.

December 21, 2006

How To Characterize Economic Policy In The 90's

A comment made by pgl in one of yesterday's posts at Angry Bear caught my attention:

And [why is chairman of Bush's Council of Economic Advisers Ed] Lazear opposed to my suggestion of easy money with tight fiscal policy, which was the 1993 approach?

What got me thinking was this:  Was the policy in the period referenced by pgl really one of "easy money" and "tight fiscal policy"?   

Answering that question requires answering the prior question of what, exactly, do those terms mean.  That is not a straightforward task, but let me give it a shot.  I'll start by suggesting -- as I have done before -- that a characterization of the stance of monetary policy -- as tight or easy, restrictive or stimulative, contractionary or expansionary -- can be found in the yield curve, or the spread between short-term interest rates and long-term interest rates.

What about fiscal policy?  I suppose that what many people have in mind is the government surplus of revenue over expenditure relative to GDP or, alternatively, the "standardized" or "cyclically-adjusted" budget surplus relative to "potential" GDP.  As explained by the Congressional Budget Office:

The size of the budget deficit is influenced by temporary factors, such as the effects of the business cycle or one-time shifts in the timing of federal tax receipts and spending, and the longer-lasting impact of such factors as tax and spending legislation, changes in the trend growth rate of the economy, and movements in the distribution and proportion of income subject to taxation. To help separate out those factors, this report presents estimates of two adjusted budget measures: the cyclically adjusted surplus or deficit (which attempts to filter out the effects of the business cycle) and the standardized-budget surplus or deficit (which removes other factors in addition to business-cycle effects).

With that background, here are pictures of the difference between the yield on 10-year (constant-maturity) Treasury securities and the effective federal funds rate...




  ...and various measures of the government surplus:




Is pgl right?  Does it look like, let's say the Clinton years, were a period of tight fiscal policy and easy monetary policy? 

You are not surprised, I presume, to see that there is a pretty good case on the fiscal policy characterization -- though it is interesting that the G.H.W Bush years look every bit as good as the Clinton years by the standardized surplus measure. (I haven't checked this carefully, but I suspect this may have something to do with smoothing out expenditures and receipts associated with the activities of the Resolution Trust Association created to manage the aftermath of the S&L crisis of the 80's, as well as adjustments for extraordinary capital gains taxes in the latter 90s.)

The case for easy money is a bit tougher.  If you accept the 10-year/funds-rate spread as being related to the relative ease of monetary policy, then the period from 1993 to 1995 looks relatively stimulative.  But the latter part of the decade is not so readily characterized in that manner -- and that is precisely the time when the budget deficits really shrink. 

The story can get complicated if you throw in the proposition that the relationship between short-term and long-term interest rates changed in the past 10 years or so, an idea that is currently in favor as a rationale for not worrying about the inverted yield curve today.  And, of course, you might reasonably object to my whole exercise by arguing that fiscal and monetary policy are really as much about what people expect to happen as they are about what is actually happening at any point in time.      

I can readily agree to the proposition that fiscal policy ought to "tighten" up - though I would emphasize entitlement and tax reform in that definition, as opposed to any particular stand on how fast or how far deficits should recede.  As for monetary policy, I'll appeal to higher authority:

Price stability plays a dual role in modern central banking: It is both an end and a means of monetary policy.

As one of the Fed's mandated objectives, price stability itself is an end, or goal, of policy...

Although price stability is an end of monetary policy, it is also a means by which policy can achieve its other objectives. In the jargon, price stability is both a goal and an intermediate target of policy. As I will discuss, when prices are stable, both economic growth and stability are likely to be enhanced, and long-term interest rates are likely to be moderate. Thus, even a policymaker who places relatively less weight on price stability as a goal in its own right should be careful to maintain price stability as a means of advancing other critical objectives.

If that ends up being "easy" money, well, so be it.   

UPDATE: pgl responds in his usual intelligent fashion, noting (as he does in the comments below), that the high-growth late 1990s did indeed call for a tighter fiscal policy.  What this suggests to me (as I also note in the comments below) is that it is not so clear that we ought to think of the stance of monetary policy in relation to fiscal circumstances.  My inclination is to suggest that something like the Taylor rule -- with its emphasis on inflation goals and the level of economic activity relative to its potential - is a more robust approach to characterizing the appropriate course of monetary policy.

December 19, 2006

Is Pay-As-You Go A Good Idea?

From the front page of today's edition of The Wall Street Journal:

Democrats are taking sides in what is shaping up as one of the party's biggest divides -- its identity on economic issues.

The brewing debate has been overshadowed by the national focus on Iraq. But at stake is the legacy of Bill Clinton and his treasury secretary, Robert Rubin, who in the 1990s redefined the formerly protectionist, free-spending party as a champion of free trade and balanced budgets. That "establishment" view now is under challenge from party populists and organized labor, who have been emboldened by gains in last month's elections to press their case against globalization and fiscal austerity.

My own leanings are probably no secret to anyone who reads this blog on a regular basis -- I'm solidly in the "free trade and balanced budgets" camp.  But there is at least one counterpoint about which I might have some sympathy:   

While liberal groups believe they have the party establishment on the defensive on trade, they complain that on budget and spending issues, fiscal conservatives have the upper hand. That stems in large part from Democrats' 2006 campaign promise to restore a "pay as you go" budget rule, which would require that any new spending, or tax cuts, be accompanied by offsetting revenue increases or spending cuts to avoid widening the deficit.

Robert Borosage, co-director of the liberal Campaign for America's Future, objects that by insisting on a pay-as-you-go approach Democrats are tying their own hands as they turn toward addressing "decade-old pent-up demands" for domestic spending.

Republicans, he says, never worry about deficits when they cut taxes. "What pay-go says is that the nation's first priority is the budget deficit, and that's just not true," Mr. Borosage says, citing instead the war in Iraq, global warming, energy dependence and trade deficits as bigger problems than the budget shortfall. "When you have a national crisis, you spend the money."

I'm a fan of pay-go rules, but there is a reasonable case to be made for the proposition that deficits have their place.  Tom Sargent explains:

Robert Lucas and Nancy Stokey, as well as Robert Barro, have studied this problem under the assumption that the government can make and keep commitments to execute the plans that it designs. All three authors have identified situations in which the government should finance a volatile (or unsmooth) sequence of government expenditures with a sequence of tax rates that is quite stable (or smooth) over time. Such policies are called "tax-smoothing" policies. Tax smoothing is a good idea because it minimizes the supply disincentives associated with taxes. For example, workers who pay a 20 percent marginal tax rate every year will reduce their labor supply less (that is, will work more at any given wage) than they would if the government set a 10 percent marginal tax rate in half the years and a 30 percent rate in the other half.

During "normal times" a government operating under a tax-smoothing rule typically has close to a balanced budget. But during times of extraordinary expenditures—during wars, for example—the government runs a deficit, which it finances by borrowing. During and after the war the government increases taxes by enough to service the debt it has occurred; in this way the higher taxes that the government imposes to finance the war are spread out over time. Such a policy minimizes the cumulative distorting effects of taxes—the adverse "supply-side" effects.

Or consider policies that have short-term costs but long-run benefits.  Think growth-promoting free trade policies that nontheless displace some domestic jobs and production today.  Or, perhaps, a health-care program (prescription drug benefit?) that immediately raises spending, but offers the promise of better health and less expensive remedial treatments down the road.  In cases such as these, you might think that because the benefits accrue to future taxpayers it would be sensible to have them bear some -- maybe even most -- of the costs as well.  And that is exactly the nature of deficits -- they shift the tax burden from today to tomorrow.

That is also, of course, the problem.  You might have noted the "under the assumption that the government can make and keep commitments " clause in the Sargent quotation above.  That is one big "if" in this discussion.  And you might suggest that it would be awfully easy for a government to claim that there are big future benefits to some set of policies, even when said benefits are suspect or highly speculative.  Or you might reasonably argue that the burdens of future taxation are already inappropriately skewed to future generations (and getting more so by the minute). 

For all these reasons, I lean to the pay-go solution.  But the contrary view is at least worth considering.

November 26, 2006

Ideological Faceoff

From The New York Times:

FOR years, the Clinton wing of the Democratic Party, exercising a lock on the party’s economic policies, argued that the economy could achieve sustained growth only if markets were allowed to operate unfettered and globally...

This approach coincided with a period of economic prosperity, low unemployment and falling deficits. Over time, this combination — called Rubinomics after the Clinton administration’s Treasury secretary, Robert E. Rubin — became the Democratic establishment’s accepted model for the future.

Not anymore. With the Democrats having won a majority in Congress, and disquiet over globalization growing, a party faction that has been powerless — the economic populists — is emerging and strongly promoting an alternative to Rubinomics.

... They want to rethink America’s role in the global economy. They would intervene in markets and regulate them much more than the Rubinites would. For a start, they would declare a moratorium on new trade agreements until clauses were included that would, for example, restrict layoffs and protect incomes.

Oh, Lord.

The split is not over the damage from globalization. Mr. Rubin and his followers increasingly say that globalization has not brought job security or rising incomes to millions of Americans. The “share of the pie may even be shrinking” for vast segments of the middle class, Mr. Rubin’s successor as Treasury secretary under President Clinton, Lawrence H. Summers, recently wrote in an op-ed in The Financial Times. And the populists certainly agree.

But the Rubin camp argues that regulating trade, or imposing other market restrictions, would be self-defeating.

That seems right to me.  What's the counter?

The economic populists argue that the trade agreements themselves are the problem. They cite several studies showing that more jobs shifted to Mexico as a result of Nafta than were created in the United States to serve the Mexican market.

Hmm.  Doesn't that argue by way of attacking with a point the other side already conceded?  Perhaps we should focus on the actual claims made by those who argue globalization is a force for good?

And then there is this:

As the two groups face off, Lawrence Mishel, president of the Economic Policy Institute, contends that the populists are pushing much harder than the Rubinites for government-subsidized universal health care. They also favor expanding Social Security to offset the decline in pension coverage in the private sector.

Expanding Social Security?  Maybe "the people" weren't as upset about growth in entitlements (via Medicare's prescription drug benefit, for example) as we were led to believe?

Is there any room for agreement here.  Sure:

Apart from such differences, there are nevertheless crucial issues on which the groups agree. Both would sponsor legislation that reduced college tuition, mainly through tax credits or lower interest rates on student loans...

OK. I'm not sure access is the problem with our educational system, but at least that focuses on a real issue.

Both would expand the earned-income tax credit to subsidize the working poor.


Both would have the government negotiate lower drug prices for Medicare’s prescription drug plan.

Uh-oh.  Price controls by any other name...

And despite their relentless criticisms of President Bush’s tax cuts, neither the populists nor the Rubinite regulars would try to roll them back now, risking a veto that the Democrats lack the votes to override.

That's interesting.

Here, I guess, is the bottom line:

The populists argue that the national income has flowed disproportionately into corporate coffers and the nation’s wealthiest households, and that the imbalance has grown worse in recent years. They want to rethink America’s role in the global economy. They would intervene in markets and regulate them much more than the Rubinites would. For a start, they would declare a moratorium on new trade agreements until clauses were included that would, for example, restrict layoffs and protect incomes.

I have a prediction: I won't lose much sleep thinking about which side in this debate I support.