Worthwhile Canadian Initiative

Words and wartime austerity

Words matter. You can't have an intelligent discussion about fiscal policy if you use loaded and misleading words to describe fiscal policy.

Cancelling or postponing a government investment project might be a wise decision. Or it might be a foolish decision. But it is not "austerity".

Implementing or preponing a government investment project might be a wise decision. Or it might be a foolish decision. But it is not "profligacy".

Real economists talk about "tightening" or "loosening" fiscal policy. They don't talk about "austerity" or "profligacy". Not when they are talking among themselves. Or they shouldn't. They don't even talk about "fiscal stimulus", which is another loaded question-begging word.

"Austerity" and "profligacy" are perfectly good words to describe the consumption decisions of a household. But they are bad words to describe the consumption and investment and taxation decisions of a government. Because public finance is not like household finance.

Economists are supposed to understand the difference. So they shouldn't use words that obfuscate the difference.

There is one important exception, where economists should talk about "austerity". And it's an exception that proves the rule.

It would be perfectly correct for economists to say that the UK government in the Second World War had a policy of "austerity". Because the purpose of that policy was to drive down household consumption as low as it could reasonably go. So it would free up as many resources as possible for the war. Yet at the same time the government ran very large deficits. Fiscal policy was extremely "loose". "Austerity" does not mean "tight fiscal policy".

(They implemented austerity by a mixture of: rationing consumer goods; persuading people to save by buying war bonds; and directly controlling the supply-side, so that firms that used to produce consumer goods were told they had to produce weapons instead.)

Fiscal Death Watchlist

I found Nick Rowe’s post Is Japan Already Dead quite inspiring so I decided to dig up the most current IMF World Economic Outlook Database for numbers on net debt to GDP ratios.  Japan – which may already be dead – has a net debt to GDP ratio in 2012 of 134 percent.  An estimate of the net debt to GDP ratio does not exist for all countries but for those for which data is available, I offer the following fun ranking: the fiscal dead, the fiscal zombie (walking dead) and the fiscal living.

Is Japan already dead?

No, I don't think it is. But I think "Is Japan already dead?" is a much better question to ask than "Will the increased interest rates from economic recovery kill Japan?"

This is just a supplement to three posts: by me; by Noah Smith; and by Paul Krugman. (This also harks back to Livio's post and my earlier post). I think I've finally figured out a way to articulate something I couldn't explain very well before.

Fiscal Equity, Taxes and GTHA Transit

Federal Finance Minister Jim Flaherty has shot down Ontario Premier Kathleen Wynne’s proposal that the 34 billion dollar Metrolinx Greater Toronto and Hamilton Area (GTHA) transit expansion plan could be funded by a special regional increase in the provincial portion of the HST.  For this to happen, Ottawa would have to agree to Ontario’s request to put a special deal in place to allow for a regional increase in the HST.  Flaherty has stated that the agreement between Ottawa and Ontario does not allow for regional variation in the HST and will not accept a proposed regional sales tax increase.  This is a pretty interesting issue.  Of course, one can debate whether a consumption or income tax increase is the best way to fund transit or whether there should be a general tax rate increase at all to fund a transit plan given that the increase goes into general revenue.  The additional money could end up not only funding transit, but also a lot of other things.  However, there are more interesting aspects to this issue. 

The Challenges of Mark Carney’s European "Mission Civilisatrice"

In his farewell address to Canada before assuming the reins of the Bank of England, Mark Carney argues that Canada works because of the strength of the Canadian federation when it comes to its institutional framework and its four critical advantages of responsible fiscal policy, sound monetary policy, a single and resilient financial system and a monetary union that works.  One cannot help but think that on these four pillars, Mark Carney will build his new international role in Europe.

The Interest Rate Time Bomb

The recent policy debate over whether its time for interest rates to start to rise after being at the lowest levels since the Great Depression for nearly five years shows just how much of a policy box governments are in when it comes to fiscal and monetary policy.  Never mind the debate over whether there is a trade-off between monetary stimulus and financial stability. Raising rates to reduce the perverse incentives on long-run economic behavior and activity comes with the risk of destabilizing public finances by raising debt service costs.

Taxation and Economic Growth

I had a bit of an intellectual crisis this evening as I pondered the conventional wisdom in economics regarding the choice between reducing consumption taxes or income taxes.  Briefly put, the simple conventional wisdom is that taxes on consumption are preferred to income taxes because they encourage saving and long-term capital formation and economic growth.  Income taxes, on the other hand, distort the labour-leisure choice and can reduce labour supply and therefore reduce economic growth.

Minding the Gap

The Mowat Centre has issued a new report on Ontario’s fiscal balance within the Federation called "Filling the Gap: Measuring Ontario's Balance within the Federation." The report finds that: “based on the latest available figures, Ontarians transfer approximately $11B on net to the rest of Canada. This transfer is equivalent to 1.9% of the province’s GDP. This can be referred to as the gap between what Ontarians contribute to the federal government and what is returned to the province in the form of transfers and spending. This gap exists despite the fact that Ontario’s fiscal capacity is below the Canadian average.”  This report is the latest installment in an effort by Ontario to redress the fiscal balance.  That the size of the fiscal gap is almost identical to the current size of Ontario’s deficit is a convenient juxtaposition.

Good Luck Balancing the Federal Budget by 2015-16

Budgets are political and aspirational documents as they lay out a future course for the economy and government revenues and expenditures much as the government of the day would like them to be.  Well, the 2013 federal budget is no exception as a bit of additional study of the budget numbers suggests that balancing the budget by 2015-16 and generating surpluses thereafter is probably wishful thinking.

Fiscal policy with Old and New Keynesian IS curves

With the Old Keyensian IS curve, the natural rate of interest is a positive function of the level of government expenditure. High G means high r*.

With the New Keynesian IS curve, the natural rate of interest is a negative function of the rate of change of government expenditure over time. High Gdot means low r*.

That's because:

In the Old Keynesian IS curve, the levels of desired C and I are negative functions of the level of r.

In the New Keynesian IS curve, the rates of change of desired C and I are positive functions of the level of r.

Please don't make me do the math. I'm not very good at math.

I have a very strong hunch that this is at the root of the disagreement between Paul Krugman and John Taylor.

I did a post on this, about a year or so back. Somewhere.

If you are a dyed-in-the-wool New Keynesian, and you want an expansionary Aggregate Demand policy, to get the economy up off the ZLB, and if you don't agree with Scott Sumner and other "monetary policy optimists", and so you want to use fiscal policy, you will want to increase the natural rate of interest, and you do that by ensuring that G will be expected to be falling over time from now on. And there are two ways to do that: either raise current G holding expected future G constant; or else cut expected future G holding current G constant. Probably: Paul Krugman wants to do the first; John Taylor wants to do the second.

John Taylor: "In contrast, in our Wall Street Journal article and our research on fiscal consolidation we consider the effect of permanent changes [presumably reductions NR] in government spending which are phased in over time to bring the budget deficit down."

Whether the New Keynesian or Old Keynesian IS curve is right, is another question.

Federal Budget Forecasting

What a difference just a few months can make in the world of federal government finance.  Apparently, weak commodity prices and a slowing economy are playing such havoc with government finances that Thursday’s federal budget will show a downward revision of economic growth forecasts as well as a shortfall in revenue that will be addressed by extra savings that will come from limiting the growth of federal discretionary spending – direct spending on programs and services as opposed to transfers.

Two extreme fiscal/monetary worlds

I want to imagine two extreme worlds, at opposite ends of the spectrum of possibilities.

In the first world (the "fiscal" world), all financial liabilities of the government are non-monetary liabilities, "bonds", that cannot be used as media of exchange. People use something else for money. Maybe gold, or maybe money issued by commercial banks. The government is no different from a local government, or a corporation with the power to tax. Government bonds pay interest.

In the second world (the "monetary" world), all financial liabilities of the government are monetary liabilities, "money", that are used as media of exchange. Unlike local governments, or corporations, the government does not issue "bonds". Government money may or may not pay interest.

Leviathan, Exit, Voice and Ontario Teachers

The last few weeks has seen the death of two economists – James Buchanan and Albert O. Hirschman - whose work has influenced my intellectual development and thinking over the years.    Their thoughts combined with tomorrow’s “political action” by Ontario teachers against the soon to expire McGuinty government has caused me to think about what forces are at work here.   To be human is to see patterns (I can’t remember who came up with that line but I’m sure it was not me) and the dispute with Ontario teachers can certainly be framed in my mind by the concepts of Leviathan, exit and voice.

Ideology, Business Cycles and Macroeconomics

Being more of an empirical bent, I do not generally indulge in the analysis of macroeconomic theory as thinking about it often causes me to recall what I think was a quote by John Kenneth Galbraith something to the effect that “Macroeconomics is like a religion, nobody truly knows what comes in the hereafter.”  More to the point, I have to admit I find modern macroeconomic theory, policy and schools of thought rather confusing having been raised in an undergraduate world where it was simply Keynesian and Classical but I digress. Yet my curiosity has been piqued, first by Nick Rowe’s January 1^st blog piece “My simple theory about why macroeconomists disagree” and then today’s piece by Paul Krugman on “Ideology and Economics”. 

My simple theory about why macroeconomists disagree.

Every other macro blogger seems to be taking a crack at this question. I like what they have to say. But I have a much simpler theory.

Let's suppose you wanted to design an experiment to test the effects of monetary and fiscal policy. And suppose you had the power to do whatever you wanted, and couldn't care less about getting clearance from the Research Ethics Board. What experiment would you design?

The Duke of Wellington on the best way to start a Japanese debt crisis

I happened to read Michael Schuman's article in Time. The title is "Will Japan's Next Prime Minister Start a Debt Crisis?" .

My immediate reaction: I hope so. Because the only thing that can save Japan is a debt crisis. It's a pity Japan didn't have a debt crisis 20 years ago, but better late than never. And the longer Japan waits before having a debt crisis, the harder it will be to control. And it will have a debt crisis eventually. But can he do it? And what would be the best way to start a debt crisis?

Cantillon effects and non-SUPER-neutrality = does fiscal policy matter?

Scott Sumner and Bill Woolsey have been fighting valiantly against the Austrians. The fight is about "Cantillon effects" -- non-neutralities of money that are supposed to arise not from the increase in the money supply itself but from where exactly that new money enters the economy.

Sometimes you get a clearer answer to a question if you change the question. That's what I'm going to do here.

Let's stop asking whether the effect of a change in the level of the money supply depends on where that new stock of money enters the economy. Instead, let's assume the money supply is growing at a constant rate, and ask whether it matters where that constant flow of new money enters the economy. We are simply redirecting that constant flow of new money, not changing the stock and redirecting it at the same time. It's easier to keep our heads straight that way.

$600b debt x (2% inflation + 2.5% real growth) = $27b

Just a little bit of simple debt and deficit arithmetic. Let's adjust the deficit for long run inflation and long run real growth. That cuts the deficit by around $27 billion.

Why Harper is Not Going to Halifax

The provincial premiers are meeting on the economy in Halifax today and tomorrow and Prime Minister Harper will not be joining them.  Several of them have offered up expressions of surprise and disappointment and have lamented the absence of the Prime Minister. The operatic drama that often characterizes exchanges at federal-provincial meetings has been absent the last few years given that one of the chief actors refuses to come.  I suppose the premiers are unwilling to replicate the Clint Eastwood approach to political discourse and simply address an empty chair.

Growing Ontario One Report at a Time

The Conference Board of Canada has chimed in on what ails Ontario and how to get it moving in a recently released report titled Needed: A Comprehensive Growth Strategy for Ontario. The report argues that after rebounding from the 2008-09 recession, Ontario has slipped into tepid growth of around 2 percent annually and needs a comprehensive economic growth strategy to improve its long-term growth potential. What is to be done?