Category Archives: fiscal stimulus

What Will the Trump Presidency Look Like?

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We unexpectedly find ourselves in uncharted territory, in so many ways. The United States has never before had a president without either political or military experience. And Donald Trump is especially unpredictable: he has so often said things that conflict with other things he has said. So it is hard to know what he will do.

But a possible precedent for what economic policy in the Trump presidency may look like sits in plain sight: the George W. Bush presidency. To be fair, the Bush family clearly did not support Trump’s campaign. But a number of parallels suggest themselves:
• The candidate won the presidency while losing the popular vote.
• The new president nonetheless believes he has a mandate for sweeping change.
• The direction of the change and the results it produces will not necessarily be what those who “voted for change” will like.
• Observers are assuming that Mr. Trump will oppose the Fed’s easy monetary policy, because he attacked it during the campaign; but I predict that when he gets into office he will turn dovish, opposing interest rate increases.
• Of his economic policy proposals, the ones that are most likely to be put into law are big tax cuts for the rich and increased spending on the military and on some other items. The result will probably be the same as when Bush enacted similar fiscal policies: a worsening of the income distribution and huge budget deficits.
• A Trump return to the post-1980 trend of increasing income inequality would follow a temporary reversal of that trend that occurred toward the end of the Obama Administration (by such measures as median family income, real wages, and the poverty rate). This is the same thing that happened in the transition from the Clinton Administration to Bush.
• The new president won’t be able to deliver his 4% GDP growth rate.
• He is unlikely to be able to increase the role of exports in the economy.
• He certainly won’t be able to make good on his promise to bring back the manufacturing jobs that have disappeared since the 1950s.
• Most worrisome of all are possible foreign policy disasters. We should fear miscalculations leading to tragedies (analogous to Bush mistakes regarding the 9/11/2001 terrorist attack, the failure to apprehend Osama bin Laden, and the subsequent invasion of Iraq). A loss of US global leadership is likely, especially loss of “soft power,” in the sense that those who live in other countries have in the past looked to the United States as a leader of the international order and as a model domestically of what they hope their own countries could be like. Finally, Trump’s cluelessness on the international stage will likely embolden some traditional adversaries, such as Russia, Syria, and North Korea.

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Fiscal Education for the G-7

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As the G-7 Leaders gather in Ise-Shima, Japan, on May 26-27, the still fragile global economy is on their minds.  They would like a road map to address stagnant growth. Their approach should be to talk less about currency wars and more about fiscal policy.

Fiscal policy vs. monetary policy

Under the conditions that have prevailed in most major countries over the last ten years, we have reason to think that fiscal policy is a more powerful tool for affecting the level of economic activity, as compared to monetary policy.  The explanation can be found in elementary macroeconomics textbooks and has been confirmed in recent empirical research:  the effects of fiscal stimulus are not likely to be limited, as in more normal times, by driving up interest rates, crowding out private demand, running into capacity constraints, provoking excessive inflation, or overheating in other ways.  Despite the power of fiscal policy under recent conditions, economists continue to lavish more attention on monetary policy.  Why?

Sometimes I think the honest reason we economics professors are attracted to monetary policy is that central bankers tend to be like us, with PhDs, and to hold nice conferences.

The reason that one usually hears, however, is that fiscal policy is “politically constrained.”   This is an accurate statement, but not a good reason for us to give up on it.  Indeed, if the political process gets fiscal policy wrong, which it does, that is all the more reason for economists to offer their contributions.

Of course if one is a central banker, or is advising a central banker, then one must concentrate on the job at hand, which is monetary policy.  But precisely because there is a limit to what central bankers can say about fiscal policy, there is more need for the rest of us to do it.

The heyday of activist fiscal policy was 50 years ago. The position “we are all Keynesians now” was attributed to Milton Friedman in 1965 and to Richard Nixon in 1971.  In the late 20th century, most advanced countries managed to pursue countercyclical fiscal policy on average: generally reining in spending or raising taxes during periods of economic expansion and enacting fiscal stimulus during recessions. The result on average was to smooth out the business cycle (as Keynes had intended).  It was the developing countries that tended to follow procyclical or destabilizing policies.

Leaders forget how to do counter-cyclical fiscal policy in the US, Europe and Japan

After 2000, however, some countries broke out of their familiar patterns. Too many political leaders in advanced countries pursued procyclical budgetary policies: they sought fiscal stimulus at times when the economy was already booming, thereby exaggerating the upswing, followed by fiscal austerity when the economy turns down, thereby exacerbating the recession.

Consider mistakes in fiscal policy made by leaders in three parts of the world — the US, Europe, and Japan.

US President George W. Bush began the century by throwing away the large fiscal surpluses that he had inherited from Bill Clinton, and then continued with big tax cuts and rapid spending increases even during 2003-07, as the economy reached its peak.  It was during this period that Vice President Cheney reportedly said “Reagan proved that deficits don’t matter.”

Predictably, the rising debt left the government feeling less able to enact fiscal stimulus when it was really needed, after the Great Recession hit in December 2007.  At precisely the wrong time, Republicans “got religion” deciding that deficits were bad after all.  Thus when President  Barack Obama took office in January 2009, with the economy in freefall, the opposition party voted against his fiscal stimulus.  Fortunately they failed then, and the stimulus was able to make a big contribution to reversing the freefall in the economy in 2009.  But having regained the Congress in 2011, they did succeed in blocking Obama’s further attempts to stimulate the still-weak economy for three years. The Republicans appear to be consistently procyclical.

Greece is the “poster boy” of an advanced country that unhappily switched to a systematically procyclical fiscal policy after the turn of the current century.  Its first mistake was to run excessive budget deficits during the expansionary period 2003-08 (like the Bush Administration).  Then, as if operating under the theory that “two wrongs make a right,” Greece was induced after its crisis hit to adopt tight austerity in 2010, which greatly worsened the fall in GDP. The goal was to restore its debt/GDP ratio to a sustainable path; but instead the ratio rose at a sharply accelerated rate, because of the fall in GDP.

Europeans suffer even more than other countries from basing their budget plans on official forecasts that are unnecessarily biased, which can lead to procyclical fiscal policy.   Before 2008, not just Greece, but all euro members were overly optimistic in their forecast and so at times “unexpectedly” exceeded the 3% ceilings on their budget deficits.  After 2008, qualitatively similar stories of procyclical fiscal contraction, leading to falling income and accelerating debt/GDP, also held in Ireland, Portugal, Spain and Italy.

The native land of austerity philosophy is, of course, Germany.  The Germans had (reluctantly) gone along with an agreement at the London G-20 Leaders Summit of April 2009 that the US, China, and other major countries would expand demand in order to address the Great Recession.  But when the Greek crisis hit at the end of that year, the Germans reverted to their deeply held beliefs in fiscal rectitude.

At first the IMF went along with the other members of the troika in believing — or at least pretending to believe — that fiscal discipline in the European periphery countries would not greatly damage their GDPs and thus could restore their debt/GDP ratios to sustainable paths.  But in January 2013, Fund Chief Economist Olivier Blanchard released a paper that was widely interpreted as a mea culpa.  It concluded that fiscal multipliers were much higher than the IMF (among other forecasters) had thought, suggesting that the austerity programs might have been excessive.  This conclusion was based on a statistical finding that the countries which had attempted the biggest fiscal retrenchment in response to the crisis turned out to experience the most damage to GDP relative to what the IMF forecasters had expected. Today, IMF Managing Director Christine Lagarde explains to the Germans that Greece cannot achieve the elusive path of a sustainable debt/GDP ratio if it is not given further debt relief and is instead told to run primary budget surpluses of 3 ½ percent of GDP.

Now to Japan, host of this week’s G-7 meeting.  In April 2014, even though the economy had been so weak that the Bank of Japan had been pursuing aggressive quantitative easing, Prime Minister Abe went ahead with a planned increase in the consumption tax (from 5% to 8%).  As many had predicted, Japan immediately went back into recession.  Even though the first arrow of Abenomics, the monetary stimulus, had been fired appropriately, it was evidently less powerful than the second arrow, fiscal policy, which unfortunately had been fired in the wrong direction.

Prime Minister Abe has indicated that he is sticking with his plan to go ahead with a further rise in the consumption tax (to 10%), scheduled for April 2017.  It is easy to see why Japanese officials worry about the country’s huge national debt.  But, as near-zero interest rates signal, creditworthiness is not the current problem; weakness in the economy is.  A more effective way of addressing the long-run sustainability of the debt is to announce a 20-year path of very small annual increases in the consumption tax, calculated so as to demonstrate to investors that the ratio of debt to GDP will come down in the long term.

Developing countries

Not all is bleak on the country scoreboard of cyclicality.  Some developing countries did achieve countercyclicalfiscal policy after 2000.  They took advantage of the boom years to run budget surpluses, pay down debt and build up reserves, which allowed them the fiscal space to ease up when the 2008-09 crisis hit.  Chile is the poster boy of those who “graduated” from procyclicality. Others include Botswana, Malaysia, Indonesia, and Korea.  China’s 2009 stimulus was very countercyclical.

Unfortunately some, like Thailand, who achieved countercyclicality in the last decade, have suffered backsliding since then.  Brazil, for example, failed to take advantage of the renewed commodity boom of 2010-11 to eliminate its budget deficit, which explains much of the mess it is in today now that commodity prices have fallen.

Politicians everywhere might improve their game if they re-read their introductory macroeconomics textbooks.

[This is an extended version of a column appearing at Project Syndicate.  Comments can be posted there or at Econbrowser.]

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Games Countries Play

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Calls for International coordination of macroeconomic policy are back, after a 30-year hiatus. To some it looks anomalous that the Fed is about to raise interest rates at a time when most major central banks see a need to extend further monetary stimulus.

The heyday of coordination in practice was the decade 1978-1987, beginning with a G-7 Summit in Bonn in 1978 and including the Plaza Accord of 1985, of which this year is the 30th Anniversary.  Economists were able to provide a good rationale for coordination based in game theory: because each country’s  policies have spillover effects on its trading partners’ economies, countries can in theory do better when agreeing on a cooperative package of policy adjustments than in the non-cooperative equilibrium where each tries to do the best it can while taking the policies of the others as given.

Then coordination fell out of fashion.  The Germans, for example, regretted having agreed to joint fiscal expansion at the Bonn Summit; reflation turned out to be the wrong objective in the inflation-plagued late 1970s.  Although the Plaza Accord and associated intervention in the foreign exchange market were successful in bringing down an overvalued dollar, the Japanese had come to regret the appreciated yen by 1987.   Some of the other G-7 summit communiques had little effect, for better or worse.  Furthermore, as the economies and currencies of Emerging Market (EM) countries became increasingly important, their lack of representation in global governance became problematic.

Since the Global Financial Crisis of 2008, attempts at coordination have made a come-back.   The larger EM countries got more representation when the G-20 became the pre-eminent leaders group.  The G-20 leaders agreed on coordinated economic expansion at the London Summit of April 2009.  They agreed at the Seoul in 2010 to give EMs quota shares in the IMF that would be more commensurate with their economic weight (though the US congress has yet to pass the necessary legislation, to its shame).

Many calls for coordination lament the outbreak of “currency wars,” a phrase that Brazil’s Finance Minister in 2010 adopted for the old phenomenon of competitive depreciation.  The concern recalls the competitive devaluations of the 1930s. The idea is that a single country can depreciate its currency, gain international competitive for its exporters and thus improve its trade balance; but if all countries try to do this at the same time they will fail.  One manifestation of the currency wars concern has been foreign exchange intervention by China and other EM countries to prevent their currencies from rising.  Another manifestation arose from successive rounds of quantitative easing by the Federal Reserve in 2010-11, the Bank of Japan in 2012-13, and the European Central Bank in 2014-15; the results were in turn depreciations of the dollar, yen and euro, respectively.

The US has led some international attempts to address competitive depreciation, including an agreement among G-7 ministers in February 2013 to refrain from foreign exchange intervention and a November 2015 side-agreement to the Trans-Pacific Partnership to address currency manipulation.  But critics are agitating for a stronger agreement backed up by the threat of trade sanctions.

The most recent fear — articulated, for example, by Raghuram Rajan, Governor of the Reserve Bank of India in 2014 — is that the US central bank will not adequately take into account adverse impacts on EM economies when it raises interest rates.

To interpret the various calls for coordination in terms of game theory is challenging, in that some players think they are playing one game and other players seem to think they are playing another game.  Consider, first, fiscal policy.  When the US urges German fiscal stimulus, as at the G-7 Bonn Summit of 1978, the G-20 London Summit of 2009; and the G-20 Brisbane Summit of 2014, it has in mind the “locomotive game.”  The assumption is that fiscal stimulus has positive “spillover effects” on trading partners.  Each country is afraid to undertake fiscal expansion on its own, for fear of worsening its trade balance, but the world can do better if the major countries agree to act together as locomotives pulling the global train out of recession.

But Germans think they are playing a “discipline game.”   They view budget deficits as creating negative externalities or “spillover effects” for neighbors, due for example to the moral hazard of bailouts, not positive externalities.  Their idea of a cooperative equilibrium is the Fiscal Compact of 2013 under which euro members agreed yet again to rules for limiting their budget deficits.

When two players sit down at the board, they are unlikely to have a satisfactory game if one of them thinks they are playing checkers and the other thinks they are playing chess.  Think of the “dialog of the deaf” that took place between the Greek governmentelected in January 2015 and its euro partners

Interpretations vary just as much when it comes to monetary policy.  Some think monetary expansion in one country shifts the trade balance against its trading partners, due to the exchange rate effect; but others think it is transmitted positively, via higher spending.   Some think that the problem is competitive depreciation and too-low interest rates; others that the problem is competitive appreciation or too-high interest rates.  Some think that the way to solve competitive depreciation for good is to fix exchange rates, as the architects of Bretton Woods did in 1944.  Others, such as some US politicians today, think that the way to do it is the opposite:  an agreement against seeking to influence exchange rates at all, even enforced by trade penalties.

Yes, regular meetings of officials can be useful.  Consultation can minimize surprises. Crisis management often requires coordination.  Exchange of views might help narrow differences in perceptions.  But some calls for international coordination are less useful, particularly when they blame foreigners in order to distract attention from domestic constraints and disagreements.

Two examples of calls for coordination obscuring domestic problems.  First: Brazil’s budget deficit was too large in 2010.  The economy overheated.  Private demand was going to be crowded out one way or another: if not via currency appreciation then via higher interest rates.  When Brazilian officials blamed the US and others for a strong real, it may have been a way to divert attention so as to avoid confronting the domestic issue.  Second:  US politicians’ ongoing efforts to ban currency manipulation in trade agreements may be rhetorical attempts to scapegoat Asians for stagnation in the real incomes of American workers.

Officials would often be better advised to improve their own policies, before they tell others what to do.

[A shorter version of this column appeared at Project Syndicate.  Comments can be posted there, or at EconBrowser.]

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