Published for johnbtaylorsblog.blogspot.com, February 21, 2012

In a recent blog Paul Krugman, borrowing from the Economics of Contempt, takes on John Cochran and me for our interpretations of the events leading up to the panic of 2008, and in particular my point that it was not the Lehman bankruptcy per se that was the underlying cause of the panic but rather the ad hoc and unpredictable policy leading up to and following the bankruptcy. The only evidence Krugman gives against my point is a plot of the “B of A Merrill Lynch US High Yield Master II Effective Yield” over a two year interval in which the crucial timing of the day to day movements are barely visible.

I first wrote about the panic of 2008 (including the Lehman bankruptcy, the AIG bailout, and the rollout of the TARP) in my book Getting Off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis, published three years ago in February 2009, which in celebration of the three year anniversary is now available as an e-book for only $2.40.

If you look at the charts in that book you will see a detailed consideration of the daily data. I focused on the spread between Libor and the overnight index swap (OIS), and showed that the major upward movements in this measure of stress occurred at the time of the TARP rollout. Moreover, this measure of risk peaked as soon as it was clarified that the TARP would be used for equity injections, suggesting that confusion about the TARP was a large source of the uncertainty and panic.

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Published for online.wsj.com, January 25, 2012

As this election year begins, a lot of people are wondering what we can do to restore America’s prosperity and create more jobs. Republican presidential candidates are offering their ideas, and at his State of the Union message on Tuesday President Obama presented his. I believe the fundamental answer is simple: Government policies must adhere more closely to the principles of economic freedom upon which the country was founded.

At their most basic level, these principles are that families, individuals and entrepreneurs must be free to decide what to produce, what to consume, what to buy and sell, and how to help others. Their decisions are to be made within a predictable government policy framework based on the rule of law, with strong incentives derived from the market system, and with a clearly limited role for government.

The history of American economic policy displays major movements between more and less economic freedom, more and less emphasis on rules-based policy in fiscal and monetary affairs, more and less expansive roles for government, more and less reliance on markets and incentives. Each of these swings has had enormous consequences. Taken together, they make for a historical proving ground to determine which policy direction is better for restoring prosperity.

A big move toward more interventionist policies started in the mid-1960s, after more activist Keynesian economists came to town in the Kennedy and Johnson administrations, and it lasted through the 1970s in the Nixon, Ford and Carter administrations. We saw short-term stimulus packages, temporary tax rebates or surcharges, go-stop monetary policy with inflationary overexpansion followed by severe contraction, wage-and-price guidelines and controls. The eventual result was high unemployment, high inflation and slow economic growth.

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Published for The Wall Street Journal, October 3, 2011

Temporary, targeted tax reductions and increases in government spending are not good economics. They have repeatedly failed to increase economic growth on a sustainable basis. What may come as a surprise is that such policies are not good politics either. Their inability to deliver promised economic benefits has invariably led disappointed voters to turn against those politicians, Democratic and Republican, who have supported them.

Consider the evidence. When President Gerald Ford entered office, the economy was in the midst of the serious 1974-75 recession. Responding to the popular clamor to “do something,” he proposed a short-term stimulus plan in early 1975. The centerpiece was a temporary income-tax rebate. Congress added a one-time, $50 increase in Social Security benefits and, to bolster the sagging housing market, a one-time tax credit for new home buyers.

The rebate caused only a temporary blip in consumer spending. Economic growth rose to 9% in the first quarter of 1976 but then dropped to only 2% in the third quarter, and unemployment started rising.

Congress enacted a second stimulus plan in July 1976 over Ford’s veto. It authorized grants to state and local governments designed to prevent layoffs of public employees or tax increases. This plan also failed to produce the promised stimulus. The economic pause of 1976 was enough to swing the election to Jimmy Carter and cause more incumbent senators to lose their seats than in any election in nearly 20 years.

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Published for Economics One, September 13, 2011

Congress was busy working on fiscal policy today. This morning, over on the House side, it held its first hearing on President Obama’s fiscal stimulus proposal. As one of the witnesses, I argued that the fiscal policy responses thus far to the unemployment problem have not been effective. Consisting mainly of short-term temporary and targeted interventions, the policy has not had a sustainable impact on economic growth and unemployment. Instead, the policy has increased the federal debt and raised uncertainty, which is an impediment to economic growth. Unfortunately, the proposals made by President Obama on September 8 consist largely of the same type of temporary and targeted interventions that have been tried for the past several years. Recent experience and past experiences show that this type of fiscal policy will not increase economic growth, certainly not on a sustained basis. It will not therefore bring the unemployment rate down to pre-recession levels which should now be the goal of policy. Over on the Senate side this afternoon, there was a hearing on more comprehensive tax and budget reform. I testified there too, along with Alan Greenspan and Martin Feldstein.  I briefly laid out a more permanent and predictable alternative to the President’s temporary and targetted proposal—a budget strategy to raise economic growth with revenue-neutral tax reform. It builds on the Budget Control Act and brings spending to the level of 2007 as a share of GDP.

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Published for The Wall Street Journal, August 17th, 2011:

The GOP plan is more effective byt may work better if the spending limits are set the way the president proposed.

As the fallout over the Standard & Poor’s downgrade makes clear, getting the country’s future finances under control will require going beyond the spending-growth reductions in the Budget Control Act of 2011 and making fundamental changes to our entitlement programs, especially Medicare. To make the Medicare program fiscally sustainable, reform must: (1) place limits on spending growth and (2) change the program to hold actual spending growth to these limits.

There are two major approaches to achieve these ends. On April 6, House Budget Committee Chairman Paul Ryan put forth a plan that transforms Medicare into a marketplace of regulated, private-insurance policies with government-provided support for insurance premiums. On April 13, President Barack Obama proposed an alternative that retains the program’s current structure with the overlay of a new, centralized bureaucracy.

Both plans place limits on spending growth that are far below that projected under the current Medicare law. The most important difference between the plans is their approach to containing spending within these limits.

The Ryan plan builds on the approach of the Medicare Part D prescription drug benefit, which has been widely recognized as a success. It encourages competition among private insurance plans and provides incentives for cost-conscious choices among plans by beneficiaries. The Obama plan would empower a new Independent Payment Advisory Board (IPAB) to analyze the drivers of excessive and unnecessary Medicare spending and recommend policies to Congress to limit it.

Full article here

Published for The Wall Street Journal, July 21st, 2011:

America added 44 million jobs in the 1980s and ’90s, when both parties showed they had learned from past mistakes. The lessons have been forgotten.

This month marks the two-year anniversary of the official start of the recovery from the 2007-09 recession. But it’s a recovery in name only: Real gross domestic product growth has averaged only 2.8% per year compared with 7.1% after the most recent deep recession in 1981-82. The growth slowdown this year—to about 1.5% in the second quarter—is not only disappointing, it’s a reminder that the recovery has been stalled from the start. As shown in the nearby chart, the percentage of the working-age population that is actually working has declined since the start of the recovery in sharp contrast to 1983-84. With unemployment still over 9%, there is an urgent need to change course.

Some blame the weak recovery on special factors such as high personal saving rates as households repair their balance sheets. But people are consuming a larger fraction of their income now than they were in the 1983-84 recovery: The personal savings rate is 5.6% now compared with 9.4% then. Others blame certain sectors such as weak housing. But the weak housing sector is much less of a negative factor today than declining net exports were in the 1983-84 recovery, and the problem isn’t confined to any particular sector. The broad categories of investment and consumption are both contributing less to growth. Real GDP growth is 60%-70% less than in the early-’80s recovery, as is growth in consumption and investment.

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Published for The Wall Street Journal, April 22nd, 2011:

If government got by with 20% of GDP in 2007, why not in 2021, when GDP will be substantially higher?

Palo Alto, Calif.

Americans are clamoring for a fact-based debate about the budget, but the numbers they’re hearing from Washington are terribly confusing. Here’s an example: Speaking at a Facebook town hall meeting here on Wednesday, President Obama sometimes talked about saving $4 trillion, at other times $2 trillion, and he varied whether it was over 10 years or 12 years, never mentioning any one year.

A simple chart, like the one nearby, would greatly clarify the debate. It shows total federal government spending year-by-year for the two decades starting in the year 2000. Spending is shown as a percentage of GDP, which is a sensible and quite common way to assess trends: When the percentage rises, government spending rises relative to total income or total goods and services produced in our economy.

For the past decade, the chart shows the recent history of government spending. For the next decade—the window for the current budget—it shows three different spending visions for the future.

The uppermost line shows outlays under the official budget submitted by Mr. Obama to Congress on Feb. 14. The lowest line shows the House Budget Resolution submitted by House Budget Committee Chairman Paul Ryan on April 5, while the third line shows year-by-year outlays I estimated from the 12-year totals in the new budget proposed by the president on April 13.

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Published for The Wall Street Journal, April 4th, 2011:

Assurance that current tax levels will remain in place would provide an immediate stimulus. House Republican budget planners are on the right track.

By Gary S. Becker, George P. Shultz and John B. Taylor

Wanted: A strategy for economic growth, full employment, and deficit reduction—all without inflation. Experience shows how to get there. Credible actions that reduce the rapid growth of federal spending and debt will raise economic growth and lower the unemployment rate. Higher private investment, not more government purchases, is the surest way to increase prosperity.

When private investment is high, unemployment is low. In 2006, investment—business fixed investment plus residential investment—as a share of GDP was high, at 17%, and unemployment was low, at 5%. By 2010 private investment as a share of GDP was down to 12%, and unemployment was up to more than 9%. In the year 2000, investment as a share of GDP was 17% while unemployment averaged around 4%. This is a regular pattern.

In contrast, higher government spending is not associated with lower unemployment. For example, when government purchases of goods and services came down as a share of GDP in the 1990s, unemployment didn’t rise. In fact it fell, and the higher level of government purchases as a share of GDP since 2000 has clearly not been associated with lower unemployment.

To the extent that government spending crowds out job-creating private investment, it can actually worsen unemployment. Indeed, extensive government efforts to stimulate the economy and reduce joblessness by spending more have failed to reduce joblessness.

Above all, the federal government needs a credible and transparent budget strategy. It’s time for a game-changer—a budget action that will stop the recent discretionary spending binge before it gets entrenched in government agencies.

Full article here

Published for The Wall Street Journal, January 28th, 2011:

Our economic wounds are self-inflicted.  Changing fiscal and monetary policies could make a difference fast.

It’s been three years since the financial crisis flared up and the recession began. Yet the unemployment rate is still over 9%—double what it was before the recession—and it’s been stuck above 9% for 20 consecutive months. Why the extraordinarily high and prolonged unemployment? My research shows that discretionary government interventions—deviations from sound economic principles and policies—have been largely responsible.

Many government interventions occurred before the panic in the fall of 2008, but in the past two years the government doubled down. We have seen an $862 billion stimulus, an increase in federal spending to 25% from 21% of GDP, and a corresponding explosion of federal debt. We have the Fed’s unconventional “quantitative easings”: purchases of $1.25 trillion of mortgage backed securities and $900 billion of longer-term Treasury bonds. And we have seen hundreds of new regulations in the health and financial sectors.

The one-time stimulus payments to people did not jump-start consumption. The stimulus grants to states did not increase infrastructure spending. Cash for clunkers merely shifted consumption a few months forward. The Fed’s purchases did not have a material impact on mortgage interest rates once changes in risks are taken into account. At best these actions had a small temporary effect that dissipated quickly, leaving a legacy of higher debt, a bloated Fed balance sheet and uncertainty—all of which slow growth and job creation.

Full article here