Sunday, March 08, 2009

Mark Thoma may be missing Ricardian Equivalent.

Let me first start off with the post and with Dr. Thoma's comments:Snake-Oil Assets Robert Shiller:
I'm not sure that confidence and too much trust on the upside and the pessimism and fear we see on the downside are the causes rather than the effects of cycles (and I'm also not sure that Shiller is making that claim). That doesn't mean that psychological factors don't have important feedback effects that help reinforce booms and busts, or that these reinforcing effects can't produce volatile swings in the economy that need to be prevented or dampened through government action, only that the changes in mood seem to be more a part of the process than a primary cause of it. But I don't want to close my mind to the possibility.
But if the effects of the psychological factors are driving the cycles then the start or the very seedlings of the cycle turns may be of little interest. It just depends on the factor weights of each of the causes of the cycles. When the cycle turns {in that instant} it may be nothing just the heard in the pact decides to go the other direction and everyone else starts to feel the draft.

From the article:A failure to control the animal spirits By Robert Shiller

The next blog post is more in line with the title in: Rogoff: Countries Risk Drowning in Red Ink Ken Rogoff with lots of gloom and doom:
That's why I wrote this. As I noted, there are plenty of people who are anxious to pin our economic problems on the deficit, and going one step further, the welfare state (e.g. the "growth could be particularly dismal, as the Obama administration steers the country toward more European levels of welfare assistance and income redistribution" statement above). But government intervention is not going to make things worse for, say, the typical unemployed worker, it will make things better by improving job prospects and providing an enhanced level of support while unemployed (health care, unemployment insurance, food stamps, and similar programs). The stimulus package won't prolong the recovery period, it will shorten it by jump starting the economy in important areas and keeping it going until the private sector can take over (think of the government spending and tax cuts as a bridge over troubled assets).
Well, being basically a conservative although when it shown externalities or deficiencies in the markets then I have no problem with interventions. At on at least one level I believe in libertarian paternalism or Pigou Taxes. So this Shock Socialism does not bode well to me in the least. Now I agree about the facts of the safety net and helping those that are low in disposable income for the short time period. But to assume that it will help people with job prospects is the question still not answered to my satisfaction. Because even if does jump start the economy which I also question based on the steps in this government intervention programs, it still may not help the individual that is unemployed. Does he have the job skills and training that will make him eligible for the new jobs? Is it in the community he lives in? Other idiosyncratic traits of the individual could hamper his abilities to get a job.

So I want to emphasize one more time that stabilization policy does not have to change the size of government in the long-run (and see pgl for a debunking of some of the claims about the size of government. i.e. he notess that "Federal spending as a share of GDP was about as high in 1985 as it is projected to be for 2019"). Fiscal policy can increase the size of government, but it can also shrink the size of government (lower taxes in the downturn, then cut spending when things are better to eliminate the deficit and government will shrink). So the criticism is not about the use of stabilization policy to help people during the downturn and to give the economy a boost, instead it's a claim about the long-term political aims of the administration with respect to the size of government. However, according to pgl's calculations, the projections are that the size won't exceed what we had under that well known socialist sympathizer Ronald Reagan.
Believe me, I am a Keynesian so I understand about taking from the abundant years and transferring them to the lean years. But some of these new proposals is an entrenchment of government and that {my friend Dr. Thoma} is the question. If anyone has not learned about how the UK handles these Fiscal Issues should look more into it. Here are two sources that I used a lot in my class {got a B not sure why}:
5. HM Treasury, ‘Fiscal Stabilisation and EMU’, Sections 2–4 Willem Buiter (2003), ‘How to Reform the Stability and Growth Pact’.

6. Carl Emmerson, Chris Frayne and Sarah Love (2001, Updated 2006), “The government’s fiscal rules”, http://www.ifs.org.uk/bns/bn16.pdf
As far as projected in 2019 being about the same size as 1985, we have some things coming that may make that comparison mute. First, baby boomers will be well into retirement and as such may not be contributing any longer to economic growth. Secondly, with this downward demographic predictions then the fact of those projections must seriously be questioned when they were basing it on over 3% growth some years and {I believe} they used 4% in out years. Thirdly, social security will then have to start paying out more than it receives. Thus the budget has to even more frugal than what it was in 1985. Until the baby-boomers start dieing off then Fiscal restraint may be hard to do.

Finally, I think I will get to my main point in this post and that is how Ricardian Equivalence {RE} is related to all this mess. The first time I read about RE, I was quite skeptical and not only for the reasons of the Homo economicus, but for the fact that who benefits from the government may be different than those that pay for the government "gifts". While the strict RE would say we are only concerned about the taxpayers and they then would know what the level of debts/deficits are. But would they take into account all factors in the debt accumulation or are they tuned into what the debt is at every moment? Heck most citizens are stupid "on the street" and not aware that Obama did not pick Sarah Palin.

I, being more of a "structuralist Neo-Keynesian" then I am thinking that RE may be apropos at this time. Right now, since Obama has become President and even after confirmation that he won by an undisputed margin then the markets and to a degree main street as well as banks have become more risk adverse. At times like this then a good Fiscal Shot in the arm could under normal conditions fill in the absorption gap.

But, and this is a big but, since taxpayers are becoming a more scarce breed in the sense that more and more workers do not pay anything into the Federal Government and may actually get some in return or pay little, then those "rich" people may understand that it means them. They no longer are sure at what the rates of return are. In addition to the normal risks involved in the market they also face uncertainty about what the tax structure will be and to handle the tax implications. If the plans were already out there as to who will face tax increases and to what amount then, maybe the markets would get back to normal.

Thus, the more that Obama seeks to stimulate the economy without saying how that it will be paid off makes the market all the more skeptical about expected returns on investments and this is increased by increasing levels of uncertainty. So far, the peace dividend does not appear to come to fruition {50k in Iraq,more to Afghanistan}, earmarks are still alive and well, not sure what taxes that Pelosi will dream up and a host of "get the rich man" is not making the investor class or even the investor class very comfortable. Dr. Thoma like me probably does not put much stake into the Ricardian Equivalence but like most economic theories, they did explain something in the past and those same factors could come around again in a different time and place. It is up to economists to try and think which models may explain the current situations and not stuck into one set of models no matter how good they are in most economies.

Talking about uncertainty: Market Uncertainty Leads to Selloff.

One last thing Dr. Thoma, one of my tutors was Dr. Paul Downward and he wrote the following that I think you may find enlightening: Reorienting Economics Through Triangulation of Methods Paul Downward and Andrew Mearman

Carry on...

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