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Jun 28, 2010


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Jon A Firebaugh

Sustainable recovery? Just be fiscally responsible and act like:
Mitch Daniels: Governing by the Numbers

Indiana, a state with just 2 percent of the nation's population, has generated 7 percent of the nation's new jobs this year"

Indiana is one of 10 states that has seen its unemployment rate go down in the past year, from 10.5 percent in May 2009 to 9.8 percent in April 2010. It has a budget surplus and a triple-A bond rating. Property taxes and the state payroll have gone down. For the first time since the 1970s, more people are moving to the state than leaving.

He treats waste in government as a moral offense. “Government isn’t a business, and it shouldn’t be run as business,” he said. “But it can be more like business. It has a lot to learn from businessmen.” Government operates without the market pressures that produce efficiency and increase quality. The challenge for government leaders is to produce those pressures to economize internally, through an act of will.

“Never take a dollar from a free citizen through the coercion of taxation without a very legitimate purpose,” he said in an interview last year. “We have a solemn duty to spend that dollar as carefully as possible, because when we took it we diminished that person’s freedom.” When you put it like that, overspending by government seems un-American. "

Also see:
Ride with Mitch

Account Deleted

Jon: You don't seem to understand. We have to "politicize" spending and debt to the benefit of one political party or the other in the next upcoming election cycle.

That way, the machine stays in power, we feel like we accomplished something by voting, and we just kick the can down the road.

There are a lot of jobs at stake depending on who is in power in Washington. It's been that way since John Marshall laid down in the law in Marbury v. Madison.

Andrew Brod

Jon thinks that the causality goes from Indiana's fiscal policies to its falling unemployment rate. Unfortunately, it rarely works that way on the state level. What's much more likely is that the Daniels' budget surplus is due to the luxury of having a (relatively) strong state economy. The governors of North Dakota and Nebraska also look like geniuses these days.

Now, that's not to say that Daniels isn't a great governor and a good steward of the voters' money. But the cause of the falling unemployment rate? Doubtful.

Jon A Firebaugh

Actually Andrew Indiana hasn't been imune from the recession, but the difference between it and North Carolina is fiscal responsibility and the eventual budget surplus in the state actually was the result of fiscal policies and not an oustanding economy. The improvement in Indiana's job creation capabilities are a result of these policies.
From the article previously linked:
"When Daniels took office, in 2004, the state faced a $200 million deficit and hadn’t balanced its budget in seven years. Four years later, all outstanding debts had been paid off; after four balanced budgets, the state was running a surplus of $1.3 billion, which has cushioned the blows from a steady decline in revenues caused by the recession. “That’s what saved us when the recession hit,” one official said. “If we didn’t have the cash reserves and the debts paid off, we would have been toast.” The state today is spending roughly the same amount that it was when Daniels took office, largely because he resisted the budget increases other states were indulging in the past decade."

In North Carolina the state legislature has robbed the Highway trust fund at least twice in the last twenty years. In Indiana Daniels auctioned the Indiana Turnpike to a private consortium for 3.4 billion or so but the state dedicated the funds to infrastructure improvement only. Result: The highways and bridges throughout Indiana that have been neglected are now being rebuilt without a tax increase.

I won't attribute all the new jobs in Indiana solely to the policies of the Daniels administration, but they have had a positive impact on corporate investment. This is an example of governance that is responsible, honest, sustainable, and the state is far better poised for recovery because of it.

Compared to the quality people Mitch Daniels brought into state government, Bev Perdue's clowns look like the keystone cops.

Jon A Firebaugh

Andrew said:
"Jon thinks that the causality goes from Indiana's fiscal policies to its falling unemployment rate. Unfortunately, it rarely works that way on the state level. What's much more likely is that the Daniels' budget surplus is due to the luxury of having a (relatively) strong state economy."

So Andrew believes that sound fiscal policies don't translate to improved employment prospects.

Right Andrew, and the Cubs will win the Series this year. Prove me wrong. Show me the great prospects for jobs in the states with the worst budgetary problems.

Jon A Firebaugh

What does your comment have to do with what constitutes a sustainable recovery? Or fiscal responsibility. Absolutely nothing.

Andrew Brod

Jon challenges me to find a sunrise before which a rooster doesn't crow. I guess he wins.


There is also a shadow inventory of 1-2 million (?) homes that have been forclosed, that are not in the existing home inventory numbers as well.

Andrew Brod

And here's what austerity (or "fiscal responsibility" if you prefer) has done to one once-strong economy. To be sure, lower taxes and smaller government helped fuel Ireland's emergence as a strong exporter in the 1980s, back when its interest rates were quite high and its primary export market, the U.K., was booming. But it's a different kind of economy now. As some of us keep noting, "worst recession since the Great Depression" is more than a glib phrase. In a liquidity trap, economic common sense gets turned upside down, and what worked for Ireland 25 years ago is obviously not working now.

The point is that the 2010 version of "fiscal responsibility" hardly seems responsible given its potential to damage our economy for years to come.


AB, could you expand on the "liquidity trap"?

Andrew Brod

"Given the massive inventory overhang in the existing home sales market it is highly doubtful that we'll see large construction employment gains in the near future."

I agree, but there's that intriguing NYT article from last month, which described increased home building in hard-hit and heavily foreclosed-upon Las Vegas:

"We’re building them because we’re selling them. Our customers wouldn’t care if there were 50 homes in an established neighborhood of 1980 or 1990 vintage, all foreclosed, empty and for sale at $10,000 less. They want new. And what are we going to do, let someone else build it?"

So even if there isn't a big bump in construction employment, perhaps there'll be a small one, as well as one in the emerging business of deconstructing homes. It used to be done with old homes with valuable materials, but increasingly it's being applied to homes built a few years ago but never sold.


Contractors are still dealing with the credit crunch, as well.

Andrew Brod

Kim, a liquidity trap is a toxic combination of very low interest rates and very low inflation. It's a scenario that generations of economists believed we'd never see again. We saw it in the Great Depression, but now we've seen it twice in two successive decades, in Japan in the 1990s and in lots of places in 2008-?.

Deflation is toxic because it puts sand in all the gears. Consumers become even more reticent to spend, because on top of economic insecurity, there's the understanding that prices will be lower next month (so why spend now?). Borrowers become reluctant because they're uneasy about having to pay back money that's worth more than when they borrowed it. So we have a crunch on the demand side as well as the supply side of credit markets.

Low interest rates are toxic at this time because they disrupt our standard recession-fighting tool kit. For decades, we've had an informal accord that pushes monetary policy into the breach to do the fighting. We drop interest rates and inject liquidity in that way. That's not possible when the government's policy interest rate is effectively zero. In fact, models show that if negative interest rates were an option (and they're not as long as people can hold cash), it'd take something like a -5% interest rate to get things moving.

Now, potentially there's more to monetary policy than just dropping interest rates. You can expand the money supply, which the Fed did in various ways starting in late 2008. That's the opposite of what was done in 1929, and it probably saved us from the worst of the financial crisis. But with the velocity of money (the rate at which funds circulate through the economy) at a very low level, that approach loses traction pretty quickly.

Ultimately, therefore, the only policy options in a liquidity trap are fiscal policy and doing nothing. Included in "doing nothing" is the array of policies currently being described as "fiscal responsibility." Normally, that'd be a great thing. I wish we'd been fiscally responsible during the expansion of 2001-07. But we weren't, and now it's the wrong policy. For one thing, we'd be like a dog chasing its tail. If we were to fall into deflation amid a commitment to "fiscal responsibility," it'd get harder and harder to find balance as wages and prices fall, because that would further depress incomes and spending, requiring more cuts, and on and on.

As we saw in the Great Depression, only a massive fiscal stimulus (in that case, the increased spending related to WWII) pulled us out of the doldrums. The smaller but still quite large stimulus called the New Deal did much good, but it was pulled back at the start of FDR's second term, much as we and the rest of the G20 are talking about doing now. The result in the '30s was the recession of 1937. We'll find out soon what the result will be here in 2010 or 2011.


Thanks for the lesson. Would you categorize the new home sales in LV as conspicuous consumption? Also, how would tax policy be effective?


Andy, thank you for your explanations. It's like a little online class. Question: Is it not possible that our economy simply must deflate for a while? Not saying it is without its downside, but that maybe it is simply a reflection of reality and that it is not without benefits.

Baby Boomers are either retiring and/or moving out of the prime production/consumption years, it just seems to this layman that with the 70% of GDP that is consumer driven shrinking and aging, that the economy is going to contract.

As for benefits, not withstanding the unemployed and the challenge to corporate profits, is it so bad for consumers, from their perspective, to go for a few years without trading up cars or houses, paying off debt and saving some money so that when those future dollars are worth more, they get more? It seems as if, for those who have income, a few deflationary years could be a pretty good thing. Combine a 3% return on US Treasuries with deflation and isn't that a great "investment?" Isn't the bond market in agreement?

Andrew Brod

Conspicuous consumption? Maybe. One could argue that there are some perfectly good houses just sitting out there and therefore building new ones is wasteful. On the other hand, we know that when houses are unlived-in, they get stale, and not just because freelance "recyclers" might steal copper pipes. Unlived-in houses aren't maintained. For all I know, it's cheaper to build from scratch rather than take a house that's been empty for three years and bring it up to speed. In other words, if you or I were in the market for a house out there, we might also demand a newly built one.

But maybe not. Maybe it's conspicuous consumption.

As for tax policy, I'm not sure there's much reason to expect tax policy to do much good at this time. Raising taxes, while potentially part of "fiscal responsibility" hardly seems like a good idea (though it might be necessary in the longer run). And tax rebates are less stimulative than direct spending or subsidies to the poor. As has been noted here, nearly half of all taxpayers pay no federal income tax (up from just under 40% before the recession), and virtually all of them are in the bottom tiers of the income distribution. Tax rebates go to people who pay taxes, i.e. the people in the middle or at the top of the distribution, and much of that money is saved rather than spent. Saving isn't a bad thing, and one can argue that those people are the ones who deserve tax rebates, but one can't reasonably argue that giving it to them is even close to the most stimulative thing we can do.

So I'd be inclined to leave taxes alone in the short run.

Account Deleted

@JAF: "Jeffrey, What does your comment have to do with what constitutes a sustainable recovery? Or fiscal responsibility. Absolutely nothing."

What is has to do with both of those things is that government spending and debt and economic recovery are always politicized and used as a tool in election cycles. (cf. Hoover between November 1932 and March 1933. Opposition to New Deal in Congress. Truman reelection 1948, etc.)

Why even now I think there is discussion about government spending, debt and economic recovery in terms of an upcoming election cycle.

Andrew Brod

Roch, I agree that deflation doesn't sound so terrible at first blush. So prices fall for a while--is that so bad? Those of us who came of age in the inflationary 1970s and early 1980s might say no. But remember that wages are prices too. Falling wages, anyone?

And it wouldn't just be falling wages. An extended decline in spending would mean an extended period of long-term unemployment. Long-term unemployment, as opposed to the episodic type we usually see during and after a normal recession, creates a cohort of permanently underemployed and under-earning people. As I believe I noted in a post here recently, lifetime earnings fall more than proportionately to the period of time unemployed, as the long-term unemployed lose ground on skills and fall behind the cohort that comes up behind them, armed with the newly-in-demand skills. The social problems created by long-term unemployment are huge as well.

I guess it comes to this. Imagine the Great Depression going on for years and years. Our recession isn't nearly as severe as that, but who can say that it won't last as long? Japan's still not fully recovered from its lost decade of the 1990s, in which it implemented fiscal policy only in fits and starts. It tried monetary easing, it tried everything else, but it dithered on fiscal stimulus, and that's at least partly why it is where it is now.

Fiscal austerity won't buy us nearly as much as we think, whereas in contrast growth can stabilize public debt pretty quickly, as a recent IMF commentary notes. No one believes that the shrinkage that would result from a general deflation would do anything to reduce the public debt.


Thanks, Andy. I am still wondering if we aren't swimming against the tide though because of our population demographics (which I am surprised hasn't yet lead to a serious discussion of loosening our immigration/naturalization policy, as that would be one way to counter the aging/retiring boomers.)

Ed Cone

I'm interested in the mechanics and the history of the policies in question.

Reducing fiscal stimulus has not worked in other times and places. Keeping the money flowing, on the other hand, replaces spending lost to the recession. It's not sustainable forever, but it would seem to beat the alternative.

Reduce waste and run government responsibly? Awesome, but somewhat beside the point here.


Roch, what effect on equity markets will boomers have as they retire, and begin to draw down their 401K's?


I've wondered that myself, Kim. The boomers start hitting mandatory 401k withdrawal age of 70 1/2 in 2016. But just because one has to take withdrawals from a 401k doesn't mean that it has to be taken out of the market permanently. People could still keep their money invested. Who knows?

Andrew Brod

Also, Roch, age 70.5 is when one has to start, not finish, taking withdrawals. A person can maintain a pretty good balance in his 401K after that age depending on how much is needed to live on, etc.

I thought I saw something about this a few years ago, and I just found it, in an online piece about retirement myths:

Stock ownership is extremely concentrated among the very highest income brackets - those in the top 10% hold 68% of financial assets, according to a 2006 study by the Government Accountability Office. These wealthy investors are unlikely to be so strapped for cash that they have to sell their shares in a hurry.

It also notes that people are working longer. I've seen the data on labor-force participation for senior citizens, and rates are indeed rising.

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