Worthwhile Canadian Initiative

Idiotic economics in the Globe and Mail. Again.

I can understand that the Globe feels obliged to provide points of view from varying points on the political spectrum. Sadly, it carries out this mandate by publishing dumb commentary from varying points on the political spectrum. On the right, it offers Neil Reynolds (typical car wreck here). And on the left, it offers stuff like today's offering from Rick Salutin:

The falling stock of workers: ... All the greats, from Adam Smith to Marx, called labour the source of wealth and value.

As Brad DeLong entertainly demonstrates (it's the graphics that make it work), the Labour Theory of Value is useless as a framework for moral philosophy or for understanding what we observe. But apparently it still passes as a basis of informed commentary in our nation's Newspaper of Record.

"Buy domestic" policies are individually irrational too

Most (all?) economists agree that in a global recession, when each country wants to boost demand for the goods it produces, policies which steer demand to domestically-produced goods are individually rational (provided other countries don't retaliate), but collectively irrational when all countries do the same.

I think most economists are wrong. It's not just collectively irrational, but individually irrational as well, at least for countries with flexible exchange rates.

In defence of crass materialism (temporarily)

Economists are sometimes accused of crass materialism. Normally I would plead innocent, and accuse the accuser of misunderstanding economics. But right now I am in favour of crass materialism. I want government investments which yield a monetary return. Government investments which make people happy but bring in no cash aren't as good right now. And it's not because "people are short of cash right now, and can't afford art galleries". It's because crass materialism leads to a bigger Keynesian multiplier.

Ricardian Equivalence and government spending

If the government takes our money (through taxes), and spends it on our behalf, does that increase aggregate demand?

If the government borrows our money, making us pay back the loan (through future taxes), and spends it on our behalf, does that increase aggregate demand?

The answer is: it depends. It depends on what the government spends the money on. It depends on whether we are able to borrow ourselves. It depends on whether we, or new immigrants, or people not yet born, will pay the future taxes. H/T Kevin Quinn.

Canada is not the United States: Stimulus-by-infrastructure edition

In an earlier post, I asked "Just who is supposed to build the new infrastructure?" Since then, no-one seems to have even attempted to provide an answer, so I'm asking it again.

I agree with the following points:

1. The US needs a large fiscal stimulus.
2. Canada needs a not-quite-so-large fiscal stimulus.
3. A US infrastructure program makes sense for the here and now.

But I question the assertion that a Canadian infrastructure program is what we need now. Here's why:

Clearly, there's a lot of slack in the US construction sector: employment is 900k (11.7%) off its peak in late 2006. Now, there's a case to be made that the construction sector had to shrink, but there's an even stronger case that it would have been better to stretch out this transition a bit. Infrastructure spending will absorb some of that excess capacity over the short term.

But Canada is not the US. In addition to what the macro data say in that graph, anecdotal evidence (ex: this comment on an earlier post and this G&M article) suggests that the Canadian construction sector is at or beyond its capacity: tenders without bids, workers called in from retirement and so on.

It's all very well to talk about "shovel-ready" projects, but major infrastructure projects are not begun by (say) laid-off auto workers wielding shovels: they are begun by skilled workers operating backhoes and excavators - and they're busy. A strategy of fiscal stimulus based on infrastructure spending seems to be based on a plan to wait until enough construction workers become available before the stimulus can start.

Government borrowing, private spending

1. "If a private firm decides to borrow more and increase its investment spending, aggregate demand will increase."

2. "If government decides to borrow more and increase its investment spending, aggregate demand will increase".

3. "If government decides to borrow more, and lend to a private firm to increase its investment spending, aggregate demand will increase."

All three sound reasonable to me, in current circumstances. A small number of economists may believe (1) but not (2). The majority of economists would say it's inconsistent to believe (1) but not (2). They ask: "What's the difference?". But then we can re-use that argument and ask "What's the difference?" between (2) and (3).

If we are considering fiscal policy to increase aggregate demand, should we also consider having the government borrow and lend to private firms instead? What's the difference?

Strengthen automatic stabilisers instead?

Suppose you believe that Canada (or the US, or wherever), needs a more expansionary fiscal policy now. If so, answer these questions:

1. Would you also recommend a more expansionary fiscal policy at some future time, if Canada ever found itself in the same situation as it is now?

2. If so, why would you want a discretionary change in fiscal policy, rather than stronger automatic stabilisers, that would work both now and in the future?

Federal budget speculation: Things you want to see and/or things you expect to see

The Conservatives will bring down their budget Tuesday, and we may as well join in the frenzy. Readers are invited to submit their proposals in the following categories (and are encouraged to add categories if the ones below don't fit):

1. Good ideas that are likely to be part of the budget: Since the Liberals have made it clear on several occasions that this is a deal-breaker for them, I expect to see some gesture towards increasing transfer payments to low-income households.
2. Good ideas that are unlikely to be part of the budget: My GST-as-stimulus proposal.
3. Bad ideas that are likely to be part of the budget: Permanent income tax cuts.
4. Bad ideas that are unlikely to be part of the budget: A commitment to take a serious chunk of change to Vegas and bet on the Leafs to win the Stanley Cup.
5. Ideas that aren't bad per se, but are pretty much useless as fiscal stimulus measures: Corporate income tax cuts, infrastructure projects.

Canadians should stop beating themselves up: it's really not our fault

Last week, my colleague Bernard Beaudreau and I were guests on the local Radio-Canada afternoon show to discuss recent events (lots of fun, BTW: if there's anything more riveting than an economist on the radio, it's two economists), and at one point I found it necessary to argue against the notion that the recession that we're now dealing with was somehow due to the failings of Canadians, the idea that somehow, we had all collectively sinned against the Gods of Economics, and now it was time to pay the price.

Paul Krugman has a series of posts trashing this theme in the context of the US recession, and it makes even less sense for us. Especially the 'living beyond our means' meme:

• We are not borrowing from foreigners; we've been running a current account surplus for the last 10 years.
• We are not borrowing from our children: governments have been running surpluses for more than 10 years.

Now, it is true that personal savings rates have declined recently, but in the context of the above points, it's not at all clear why that's a big problem. Here's a wonderful graph from the early days of WCI:

If Canadians slowed their rates of personal savings over the past few years, then at least part of the reason why they did so was that they saw less of a need to compensate for the other two sources of national savings.

More generally, the problems we're seeing cannot be ascribed to any obvious failing on the part of Canadian households or of Canadian governments. We've done our homework, eaten our vegetables and saved for a rainy day. The storm is upon us, yes. But we shouldn't be thinking of it as a form of retribution for our sins.

How do we reduce our debt/income ratios? The paradox of debt.

It's a common theme that the financial crisis was caused by too much debt, relative to our incomes. So if we want to get out of the crisis, we need to reduce our debt/income ratios. How?

For an individual, the answer is easy and obvious: spend less, save more, and pay down debt. But for a country as a whole this won't work. If everybody tries to save more, and spend less, income falls (because one person's spending is another person's income). The paradox of thrift tells us that if investment, net exports, and the government deficit stay the same, savings stays the same, so that the attempt to save more fails. The paradox of debt is like the paradox of thrift on steroids. If we each attempt to reduce our debt/income ratios by saving more, income falls, and so our debt/income ratios rise, making the problem worse, not better.

Three reasons to believe the Canadian fiscal multiplier might be bigger than we think it is

1. The Short-Run Aggregate Supply curve is not vertical, otherwise fiscal policy (or any change in Aggregate Demand) would have no effect on real output (except via supply-side effects). But the SRAS curve is probably not linear either. It is plausible to assume that the SRAS curve gets steeper as output increases, because as output increases more and more sectors of the economy hit bottlenecks, and cannot or will not expand output in response to an increase in demand.

Canada and the Eurozone: a comparison

I keep an eye on various European economics blogs (especially VoxEu and Maverecon). We often compare Canada and the US. I want to compare Canada and the Eurozone, just for a change. I want to revisit the Optimal Currency Area question, in the light of the financial crisis. The Eurozone is like Canada would be, if we abolished the Federal government, and had to rely on the provincial governments only. That's very worrying (for the Eurozone).

Default, expected default, and wealth

Actual default on existing debt reduces aggregate wealth a bit; expected default on existing debt reduces aggregate wealth a bit; but expected default on new debt reduces aggregate wealth a lot. Redistribution of wealth from creditors to debtors may reduce aggregate wealth a lot. Default is a symptom of that problem.

One useful insight from Austrian business cycle theory

I am not an Austrian, but...

Three decades ago (ouch!) I made a valiant effort to understand Austrian business cycle theory. I failed. I wanted to believe it, because I found the existing theories (Old Keynesian or New Classical) unsatisfactory. But I couldn't get it to make sense.

The changing game between monetary and fiscal authorities

Who's in charge of aggregate demand?

Monetary policy affects aggregate demand; fiscal policy affects aggregate demand. How the monetary authority acts may depend on how it expects the fiscal authority to act, and vice versa. What happens depends on the rules of the game they are playing. The rules of the game have changed in the last month in many countries. In Canada the new rules are very unclear.

Loanable Funds and Liquidity Preference; DeLong vs. Fama

This is a (probably hopeless) attempt to clarify the debate between Brad DeLong and Eugene Fama over whether an increase in government spending, financed by borrowing, will increase aggregate demand. There's something important that's missing from the debate: the rate of interest; and money.

Employment in the current and in previous recessions

Alex Tabarrok at Marginal Revolution has posted a graph comparing the decline in US employment during the current recession with what happened in the past, and Menzie Chinn at Econbrowser has offered a similar graph for industrial production. At first glance, these graphs seem comforting: the current experience seems to be following a moderate course, somewhere in the middle of what we've seen before. But closer inspection shows that all of the paths beneath the current one occurred more than forty years ago, and it's far from clear that those data are directly comparable to what we're seeing now.

What would a Canadian version of those graphs look like? Rather less busy, it turns out. The headline employment numbers are from the Labour Force survey, which started in 1976. Since then, there have been precisely two episodes in which employment declined in a significant way: 1981-82 and 1990-92. I've tracked down a discontinued payroll series that goes back to 1961, but the only thing I could see there was 1970, where employment went sideways. Before that, there's nothing. So in my lifetime (I was born in 1961, which places me in the largest cohort in the Canadian demographic pyramid), there have been only two employment recessions to speak of. Here is what they looked like:

It's important to remember that we're only two months into the recession; our American cousins have been riding this roller-coaster since December 2007. As I mentioned earlier, forecasters are (so far) expecting a fairly mild recession; I've included the most recent Conference Board of Canada projection to illustrate the difference between those forecasts and what we've seen before.

I'll be updating this graph as we go.

A request for some Bayesian assistance

Calling all Bayesians! I need your help on two questions: first I want you to check something I said; second I want you to check something that Bryan Caplan said.

In September 2008, Bryan Caplan issued a challenge (revisited yesterday) for people to say in advance how they would update their prior belief that the bailout would prevent disaster, conditional on observing no disaster. ("Disaster" was defined as greater than 8% unemployment). He was absolutely right to issue that challenge, because otherwise people could say that their view was confirmed whatever happened.

Pump-priming and the Keynesian Laffer curve

Update: since what I thought was my most controversial post ever has drawn precisely zero comments, let me re-title it: "A fiscal stimulus can more than pay for itself".

The English language is full of dead or dying technological metaphors. How many people have ever primed a pump or kick-started a motorcycle? (I'm old enough to have done both.) In both cases you give the machine (the pump or motorcycle) some temporary outside assistance (add water or kick down on the kick-start), and then it keeps on running by itself.

These metaphors are sometimes applied to fiscal policy. The idea is that a temporary increase in government spending or cut in taxes can get the economy running again under its own power, so that the fiscal stimulus can be withdrawn.

Probably not the best stimulus proposal I've seen so far

The Quebec government released an economic statement thingy (pdf) today, announcing six measures to counter the recession. Here is number five:

[W]e are acting on our commitment to raise the minimum wage to protect the
purchasing power of low-wage workers. The minimum wage will be raised by 50
cents an hour next May 1, bringing it to $9.00 an hour.

Memo to whoever came up with this idea: Labour demand curves slope down.