Screw Your Coreage to the Sticking Place
http://krugman.blogs.nytimes.com/2011/01/3...

http://posts.revolvingplanet.net/you-cant-...

Previous Parts: Part 1 Part 1b
The take away for this last part is that if someone is against a budget deficit and against a falling dollar, then they are for a smaller economy and more unemployment.

For this last part I'm going to skip using phrases instead of equations. It would just be too long to write things out that way. The main point of these blogs is to point out the silliness of much that we hear in the media and from politicians. Somehow a worldwide financial crisis and the busting of the biggest real estate bubble in history has turned into an effort to cut the US budget.

That the proponents of these cuts are arguing that 2+2 doesn't equal 4 doesn't seem to bother them. Some have proposed that it is a feature not bug. The Republicans know what they are arguing will kill the economy but they see that as a way to wrest the Presidency from Obama. The other option is that they just don't realize what they are saying is a war against basic arithmetic. I tend to throw my lot in with the first group. Clearly nothing the GOP has done, or refused to due, like allow the Senate to vote, has had anything to do with helping the country and everything to do with harming Obama.


GDP

We are all familiar with the Gross Domestic Product (GDP) measurement of the economy. It measures the value of all goods and services created in the economy during a set time period. Equivalently, it also measures the amount of income people have received in the economy. To understand why the two ways are equivalent we just need to realize that every dollar someone earns as income has to come out of the pocket of someone else as spending.

So lets look at the different components of GDP.

GDP = C + I + G + (Exp - Imp)

C is personal consumption. I is investment by firms. G is government spending. (Exp - Imp) is exports minus imports.

Just to help clear the cobwebs lets imagine for a moment that all the variables on the right side of the equation are independent. That is , if one variable changes that doesn't imply any particular change in the other variables. The other variables stay the same. Hopefully it is clear that, in that case, when a particular variable goes down then GDP goes down. Consumption goes down, everything else stays the same, so GDP goes down. It may seem odd to argue for basic arithmetic but, as we shall see, those taking certain positions are essentially arguing against it.

On this basis it should be clear that anyone arguing one component of GDP can go down without the economy shrinking must be arguing there is some mechanism that makes another component go up. So what are the mechanisms and how do they apply to current conditions?

Consumption, Investment and the Interest Rate
Today the rate of consumption has dropped from previous levels. Mostly this is due to people realizing the the owe more than there stuff is worth. Housing prices have crashed and people now want to pay down their debt. The private savings rate has swung from -3% before the crash to +5% now.

In normal times a drop in consumption is not such a big deal. As the amount of money being saved goes up the interest rate drops and businesses borrow that saved money to invest. While that is happening now, it is not happening at a rate to make up for the lost consumption (increased saving). Back in Feb 2009 the Fed estimated that the interest rate would have to be -5% in order to induce businesses to invest enough to make up for the drop in consumption. But, banks don't pay people to borrow money so the actual interest rate is 0% and can't go any lower.

Crowding Out and Future Taxes
Now we have people who say they want to see G go down too. Even President Obama has said the government needs to tighten its belt too. As we've seen, if G is going down, then we have to have a mechanism for something else to go up or GDP itself will shrink.

Crowding out is a phrase most often thrown around by the right but all economists admit there is at least something to it. Imagine a healthy economy where the interest rate is just right to get firms to invest all the money people are saving. Now, imagine the government comes along and wants to borrow some of that money too. The increased demand for loanable funds will cause the interest rate to rise. Because of this rise, some firms will decide not to borrow in order to invest. So in this case G going up has made I go down.

There is debate about how important the crowding out effect is even during normal times. Some of the things government borrows for are not things the private world buys. Roads and education would be two good examples that are known to have very high returns in terms of growing GDP. So there is debate on how much of a government spending increase just raises GDP and how much of the additional spending are eaten up by decreased investing (crowding out).

These aren't normal times however. We've already seen that investment isn't keeping pace with decreased consumption even. It is hard to imagine that the government increasing saving even more would somehow spur more investment. Another way to say this is , if interest rates want to be at -5% now and government spending, in effect, pushes that up to "only" -2% we are still at a desired negative interest rate. The actual rate will stay at 0% and there will be no crowding out.

Since there is no crowding out presently, the reverse case where we actually decrease government spending will cause GDP to shrink. There is no pent up, crowded out investment waiting to take over from the government. In fact, right now we should expect higher government spending to have a crowding in effect. Since all of the spending will go to propping up or increasing GDP firms should be slightly more willing to invest at any given interest rate.

Future taxes is another mechanism sometimes proposed for how cutting government spending might help. The idea is that by looking at the deficit people get so afraid of future tax increases that they stop spending or even drop out of the workforce because why work if it is just all taxed away. The problem is there is very little evidence that such an effect exists. There are many reasons for it but the bottom line is that most economists consider future taxes concerns as a disproved idea. See here for more.

So, it's 2 strikes for deficit reduction. Now on to international trade.

The Exchange Rate
So, consumption is down, investment is not up enough, and the pain caucus wants to cut the deficit. That only leaves us with the trade portion of the GDP equation. Right now our Exports - Imports is negative, we import more than we export. Still this portion of GDP is actually pretty small. I forget the actual number but international trade (exports and imports) is only about the size of 10%-15% of GDP.
So there doesn't seem to be a lot of hope to get to where we want with using trade. Still lets look at how we might go about growing exports.

The number one thing that drives the trade balance is the value of the currency. Let's see how it works. Let's say our currency goes up from a given level (becomes stronger). In that case it becomes more expensive for other countries to buy the dollars that they need to have to purchase American goods. On the flip side it becomes less expensive for us to buy the foreign currency we need to buy their goods. In this case our trade deficit would become larger. I.e. Exports - Imports becomes more negative. If the opposite happens we get the opposite results. It becomes less expensive for other countries to buy the dollars they need to buy American goods so they buy more. It also becomes more expensive for us to buy the foreign currency that we need to buy foreign goods so we buy less of them. In that case the trade deficit goes down.

This is the only short term mechanism known for changing the trade portion of GDP. If you are against the dollar falling then you are against the trade portion of GDP adjusting to make up for the shortfall in consumption (if it can even change that much realistically anyway).

Strike 3 you're out
This is strike 3 for our group against deficits and strong dollar advocates. Consumption is down due to people paying off debts. Investment is not picking up all the slack due to a unpleasant economic outlook and interest rates not being able to adjust to negative values. But the pain caucus is ideologically opposed to keeping government spending elevated and to the dollar falling (they call it debasing the currency). So they have come out against the only two possible means to make up for the Consumption+Investment shortfall. There is only one conclusion. Whether they know it or not they are arguing for the GDP to fall and therefore for more people to be out of work. This conclusion has very little to do with any particular economic theory. It is a result of basic arithmetic.

ECON 101 FAIL

OK, folks. It's time for a refresher on basic national accounts. Treasury Secretary Tim Geithner is interested in reducing current account surpluses around the world without devaluing the dollar. Good luck with that.

...

As a matter of pure accounting, there are exactly the two ways to avoid large government deficit. One is for private investment to rise. Unfortunately, unemployment is at 9.6 percent and capacity utilization is low. Businesses have no incentive to invest in more capital when they have existing capital already going to waste. The only other way to avoid increasing government deficits is to increase net exports. Econ 101 says the dollar must fall relative to other currencies in the world.

So when unemployment is high, capacity utilization is low, and devaluation is unprincipled, what is left to do to increase national savings? Declare war on algebra?

As for Geithner, he has a little more wiggle room, reportedly declaring that the fiscal consolidation will wait until the recovery strengthens.

You can't cut your way to growth. Part 1b: A night at the theater?
Previous Parts: Part 1
Later Parts: (None Yet)

In this series of posts I'm looking at the relationships between various entities in an economy. Partly I'm trying to document, for myself, the information I have gleaned from the like of Paul Krugman, Dean Baker, Mark Thoma, and Brad DeLong. All of these guys have devoted a lot of time to explaining the foundations of macroeconomics at a layman's level, but often that information is spread out over many blogs and many months. I'm trying to pull it all together and put it in my own words.

In the first part we saw how a person who wants to save or pay down a debt may be thwarted by the fact that no other part of the economy wants to pick up the slack from the saver's reduced consumption. The desire for investment funds is low so the saver ends up with a pay cut and less saving than they had hoped. The key take aways were that when one variable changes in the GDP equation, one or more of the others must change as well, and how they do so will be determined by what mechanisms are available and plausible. If consumption goes down then either investment will go up, through the interest rate mechanism, or GDP will go down.

Morality Play?

Some people want the results of these adjustments to be some kind of morality play. People in debt are bad people. After all, they are probably poor and we all know being poor is a sure sign of lax morals. They may not care that the person in our example last time saw his income go down. After all, he was in debt, he had it coming. Unfortunately for the people with this POV (not me by the way) the economy cares not for such things.

I want to look at the reason why by breaking down further our equation from last time. We'll do this by breaking down our consumers in to 2 groups. The first group is our slovenly, indebted people and the second group is our virtuous debt free folks.
We start where we left off with this,

Total Income = (Individual Income - Individual Saving) + (Investment)

and break it down into our two groups

Total Income = (Indebted Income - Indebted Saving) + (Debtfree Income - Debtfree Saving) + (Investment)

Lets use some numbers.

$20,000 = ($10,000 - $0) + ($10,000 - $0) + $0

As we saw last time, when our indebted person tries to pay down his debt by $1000, only $500 of it got picked up as new investment and so total income went down by $500. In this case that would mean,

Total Income = $19,500 = (? - $500) + (? - $0) + $500

But who takes the income cut? There is no mechanism in the economy that makes sure the guy that is in debt will take the hit. In our example the person paying down debt decided to get the money to do so by cutting out his morning trip to Starbucks. It could be the case that our virtuous debt free guy works there. It might be the case that he is the one who takes all of the hit and it could look like this,
$19,500 = ($10,000 - $500) + ($9,500 - 0) + $500

If we could get our virtuous person to spend more by taking on some debt himself (have a negative saving rate) then we would be OK and Total Income would never have to fall in the first place:
$20,000 = ($10,000 - $500) + ($10,000 - (-$500)) + $500

Unfortunately this mechanism is blocked for the same reason the investment mechanism was blocked. The interest rate is already at zero and can't move any lower. So the economy will shrink and it doesn't care how virtuous the recipient of this pain is.
Does the Interest Rate need to be negative right now?

I thought I should back up my claim about the interest rate needing to be negative. This is from about a year and a half ago but it is a good example of what I'm talking about. I, unfortunately don't have a more recent number but we can infer the Fed thinks the number is still negative from their actions. There is no talk of raising rates any time soon, in fact they have embarked on a new measure intended to emulate negative interest rates, quantitative easing.

April 27 2009
The ideal interest rate for the US economy in current conditions would be minus 5 per cent, according to internal analysis prepared for the Federal Reserve's last policy meeting.

The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation.

A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5 per cent.

People are saving?

Remember, we are defining saving as anything not spent on consumption. So you can be in debt and be saving at the same time. All we care about for determining Total Income is how much of their personal income people are spending on purchases. Unfortunately the term "saving" gets used in a lot of different ways in the press. Sometimes an article is just referring to how much people are putting in a savings accounts so it can be confusing. I'll use a graph from the Fed that is defining saving the way we are using it.



As you can see, saving is indeed way up since the collapse.

Go Investors Go

Investment has been picking up some of the slack fortunately. Taking a look at this GDP table we can see that it increased at a pretty steep pace earlier this year, it just hasn't been enough to take up all the extra saving.

You can't cut your way to growth. Part 1

Cutting budget deficits is all the rage. After all, everyone "knows" that being in debt is a sure sign of someone with lax morals. At least, that is how it is sold. It is claimed that, somehow, getting the US budget deficit under control will lead to growth and prosperity, i.e. jobs. What most people care about right now is the jobs part of the equation; getting new ones, keeping old ones, and making sure their income doesn't go down at the ones they keep. But, will cutting the budget deficit do the trick in the current environment? The answer is no, and not because of any particular economic theory. It isn't the result of a liberal theory, or a conservative theory. It starts from basic arithmetic followed by examining the actual situation we find on the ground in the economy today.



Many people hate math but my hope is that sticking to basic arithmetic will make this all more palatable to read. I plan to start with a simple model of the economy and work my way up. The point here is to learn how to reason about relationships in the economy and in later parts to specifically talk about government deficits. I'm using phrases in the equations instead of the typical variables but this all ties back to how economists calculate things like total output of the economy (GDP). Let's look at an economy that has producers and consumers with no government and no other countries and look at the size of the economy.

First we note that, for any given time period, it must be true that:

Total Income = Total Spending

This is not an economic theory, this is just basic double entry bookkeeping. A dollar that comes out of someone's pocket as spending, must show up in someone else's pocket as income or something has gone wrong with our record keeping. It should be noted that producers and consumers both show up on both sides of the equation. Producers can have income and can also spend by buying new equipment and the like from other producers.

It can be useful to break these quantities down in to different components so we can see how parts of the economy interact.

Total Income = (Individual Consumption) + (Investment)

Individual Consumption is what people buy for themselves and investment is spending by firms on equipment, buildings, etc.

Let's assume that Investment doesn't change but individuals would like to consume less (save more) and have income stay the same (i.e. have the economy not shrink). Can they do it? No. Obviously if Individual Consumption goes down and Investment stays the same Total Income must fall. If we want the size of the economy to stay the same we will have to get rid of our assumption that Investment doesn't change.

If we could somehow get the Investment to rise then we would be ok. It could just happen that firms want to invest more just at the right time that people want to consume less but it is not a given. In fact, seeing less spending(demand) for their goods may have exactly the opposite result. Fortunately, in normal times, there is a mechanism to encourage this increase in Investment. It is the interest rate. You can kind of think of the interest rate as related to supply and demand of loanable funds. As people spend less and have more to lend, the price of borrowing that money goes down.

This introduces the concept of a mechanism. If one of the variables changes then there are two other variables that change with them. Consumption changes so either Investment, Total Income, or both will have to change. The mechanism without an interest rate is that firms see less orders for their goods so they cut back on production , i.e. lay off workers, and the Total Income goes down. With an interest rate, the interest rate itself is the mechanism which brings things back to equilibrium , hopefully at the same Total Income level.

There can be several reasons why consumers as a whole may decide to cut back on spending. The most obvious are to put money away for the future or to pay down debt. We can break down our equation even further to look at how this desire to save interacts with the economy. First, lets look at a very special case where individuals spend everything they personally earn as income. In other words,

if, (Individual Consumption) = (Individual Income),

then Total Income = (Individual Income) + (Investment)

Now lets introduce the concept of saving. In that case we have,

Total Income = (Individual Income - Individual Saving) + (Investment)

It should be noted here that we are defining Saving as any income the individual isn't using for consumption. In the real world this could mean putting money in the bank. It could also mean paying down an old debt or buying a bond. None of those are consumption and would show up in our bookkeeping as investment once a firm borrows the money back out to buy something or uses the money you gave them for the bond to buy something.

Going back to our example of a person who wants to change their spending habits we can use our equations to look at a scenario. I think at this point it is best to use some numbers in the equations instead of asking people to imagine what happens when a variable is changed. In the example we will assume that changing the interest rate is not possible. This is not so far fetched. It is in fact the situation we are in right now in the real world. The rates banks can borrow from our central bank, the Fed, are as low as they can go. The rates banks give are of course higher but this is because they must account for administrative cost and the risks they perceive in the economy. There is nothing we can do to drive these rates lower because the central bank rates are already essentially at zero. In the examples we'll assume that some of what is saved is used for investment but not all of it.

Lets start with someone who wants to save a certain amount but that amount is flexible. He used to spend every dime they made but they've decided they really don't need that coffee from Starbucks every morning. They might as well sock that money away. He starts by making and spending a fixed $10,000 every month. He decides to cut his expenditures down to a fixed $9,000 a month and save the rest.

We start here,

Total Income = (Individual Income - Individual Saving) + (Investment by firms)

$10,000 = ($10,000 - $0) + $0

Now he tries to save,

? = ($10,000 - $1,000) + $500

= $9500

Oops. Income went down because not all of his saving got picked up as investment. This guy is flexible though. He just wants to spend $9,000 a month and save the rest. He can just save less to bring things back in to balance at the new , smaller , total income (GDP) of the economy.

$9500 = ($9,500 - $500) + $500

He tried to save $1000 but instead he saved $500 and got a pay cut.

I'm going to stop at this point. The key idea to take away from this is that this result is not from any particular economic theory. It is a result required by basic bookkeeping . In order for one person to save more another person must spend more. Otherwise the person that wanted to save won't be able to save as much as they planned. The key fact to take away is that right now we are in a situation where the interest rate can't adjust anymore. There needs to be a negative interest rate for things to balance out but you can't have a negative interest rate. This discrepancy between rates is important for understanding why things that might normally have bad consequences don't right now. It is important to understand these bookkeeping relationships and demand from anyone that claims doing X will produce Y what mechanism they propose will be at work to make it happen.

I hope to be able to tackle the next part that includes the government this weekend. We'll see. I don't blog much and this is hard work when you have a 2 year old running around. In any case, consider what the government's role might be with respect to the missing $500 above. Also, consider what might be the case if government spending was a part of total income and was cut at the same time as people saved more. Finally, consider what might happen if the person saving is actually paying down a debt and can't reduce the amount they are trying to save. Our simple model implies this could lead to a downward spiral. Only half of the $1000 ever gets invested and so total income must keep falling to try to get back in equilibrium.

Tortured logic

Tortured logic
The 'ticking-bomb' scenario, as an argument for torture, is potent. It is also silly, says one philosopher, and corrupt.

...A nuclear weapon is set to go off in Manhattan within hours. You have a terrorist in custody who knows where the bomb is, but he's not talking. Do you torture him for information?

...

Whether a fraud or a piety-puncturer, the ticking-bomb scenario is certainly potent. In an essay in the new collection ''The Torture Debate in America'' (Cambridge), David Luban, a Georgetown law professor and philosopher, explains its one-two rhetorical and philosophical punch: First, it magically transforms the stereotypical torturer from a sick, sadistic figure into ''a conscientious public servant, heroic the way that New York firefighters were heroic.'' Second, it suggests that once you give up a principle in an extreme case, ''all that is left is haggling over the price.'' That is, your moral standard was pretty lax to begin with.

But this notion that if you give in when Manhattan is on the line then you must not really oppose torture ''has got to be wrong,'' Luban says in an interview. ''That generates a cheap argument against anyone who believes in any absolutes.'' Imagine, for example, that you believe abortion is always and everywhere wrong. Are you a ''phony'' if you would nevertheless have an abortion if a tyrant told you that if you did not, he would slaughter every member of your family? You can load the dice that way against any moral position.

...

...If there were 100 people in custody and only one had the information needed, but you didn't know which one, would you torture all 100? Or would you torture a terrorist's innocent daughter if she happened to know where the bomb was but out of misguided loyalty remained silent?

''We can all be persuaded to draw the line somewhere,'' Waldron wrote in the October issue of the Columbia Law Review, ''and I say we should draw it where the law requires it, and where the human rights tradition has insisted it should be drawn.''

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Of course, such dueling abstractions are a long way from what America may be doing, or may have done, to so-called high-value detainees. And that's perhaps the ultimate problem with the scenario. Its facts are so stylized as to be fantastical: You know there really is a bomb; you know you have the right man in custody; you know torture would elicit the crucial information. Elaine Scarry, a Harvard English professor and scholar of torture, has suggested that while we're making up such artificial rules, why not add just one more: You also know where the bomb is. Problem solved!

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(more)

If Tyranny and Oppression come to this land, it will be in the guise of fighting a foreign enemy.

-- James Madison, "father" of the U.S. Constitution

Of all tyrannies, a tyranny exercised for the good of its victims may be the most oppressive. It may be better to live under robber barons than under omnipotent moral busybodies. The robber baron's cruelty may sometimes sleep, his cupidity may at some point be satiated; but those who torment us for our own good will torment us without end, for they do so with the approval of their own conscience.

--C. S. Lewis

They that can give up essential liberty to obtain a little temporary safety deserve neither liberty nor safety.

--Benjamin Franklin

I have sworn upon the altar of god, eternal hostility against every form of tyranny over the mind of man.

--Thomas Jefferson