A reply to Nathan

A youngster called Nathan replied below, and I decided his points needed more attention than is in the comments section of a blog. So here we go. You may wish to read my compendium of economics articles first, I reference them widely in this article:

That said, I entirely disagree that spending for spending sake helps the economy. If it did, why don't we just pay every American one million dollars to dig a hole in their back yard?

Keynes actually addresses that one and why it will not work, and Paul Krugman and Brad DeLong have both covered that one on their blogs when addressing why the bank bailouts and last spring's tax cuts did not work. The critical factor is what Keynes called the propensity to spend. You can't just give money to people and expect it to be useful. In a down economy such as now, on a microeconomic level the propensity to spend is low -- people are instead saving their money in case they lose their job, thereby causing lost jobs due to the paradox of thrift, or they're paying down debts, both of which are good things to do when there is a shortage of investment money but with U.S. Treasuries at 0% interest right now, it's clear there's no shortage of investment money. So just giving money to people with no strings attached doesn't work. Instead, you have to give money to people in exchange for people doing something of value. There has to be strings to attached. Such as, "we will give you this money if you will build us a bridge to replace the collapsing bridge that was built in 1935 by FDR's NRA." The money then gets spent on steel for the bridge, and on steel riggers who then spend their money on beer at the local restaurants, which then hire waitresses, who then can afford to buy used cars from steel riggers who can now afford to buy new cars, etc. That is why infrastructure spending has a high multiplier rate compared to most other forms of government spending, as shown by this graph (clicky to embiggen it): Which brings up your next point:

So where does loose fiscal policy come in? Easing the tax burden.

See the above graph. The problem is that there's not much room to do anything there. The propensity to spend is not there, so any tax cuts you make right now will simply go under mattresses being saved in case people lose their jobs, rather than being used to buy stuff. And tax cuts to businesses are even worse. Businesses will not expand employment right now because they don't see enough buyers for their goods. They'll just stuff the money in their mattresses too. We've run full speed ahead into paradox of thrift territory . We have a fundamental disconnect between the amount of goods flowing in the economy, and the number of consumers willing to buy said goods. We have sufficient goods, but we don't have sufficient buyers for the goods to keep all the workers employed, and keeping workers employed is one of the fundamental roles of modern economic policy, because unemployed workers are revolting -- literally. There were food riots throughout the United States in 1932, and a real chance of a Communist revolution. Idle hands are the devils' workshop and all that.

So we've hit the end of tax cuts as a useful policy. The United States is already the least-taxed of all the OECD nations other than Mexico, and I doubt you want to see us be Mexico North. Or maybe you do, but if you do, that's the end of this conversation because then we have a fundamental conflict of values similar to the conflict of values I have with the Taliban, where there is no useful discussion possible.

I see about four levers that the government has in combating a recession:

1. monetary policy
2. fiscal policy
3. tax policy
4. leadership

We have arrived at the limits of monetary policy. With monetary policy we are pushing on a string, pushing money into the system, but not addressing the fundamental disconnect between supply and demand that is causing employment to decline. We have arrived at the end of the usefulness of tax policy, as shown by the graph above -- because of the paradox of thrift, tax policy is also no longer capable of addressing the fundamental disconnect between supply and demand that is causing employment to decline, because any tax refunds are going towards savings, not towards demand. That leaves leadership and fiscal policy on your list. The fundamental task must be to employ the unemployed via whatever means are most effective. Infrastructure spending to employ the hundreds of thousands of people who lost jobs in the construction industry last year would be a gigantic boost. Aid to the poor -- who spend what they get, thus any money sent to them goes directly to spending rather than to paying off debts or savings -- would also be a major boost to demand. Anything targeted at the middle and upper classes simply will have no effect in this current scenario, as far as fiscal policy is concerned.

But personally, I think you are being far, far too conservative on the leadership thing. Our banking system has failed. We need to do a Year Zero on our banking system -- admit that our five largest banks that collectively control over 80% of our banking system are all bankrupt and create a new "Bank of the United States" to take over all their assets. As part of Year Zero, all personal credit card debt would be wiped out, fini, done, and this new "Bank of the United States" would immediately write all mortgages that it took over as part of that transaction down to a reasonable percentage of family income so that people could afford to stay in their homes and would have money left over to spend, rather than sending all their money to the banks in a futile attempt to pay off unpayable debts. This would create an immediate and gigantic boost to spending, because money currently going to paying unpayable debts would then be going towards both consumption *and* savings. Consumer debt would not be easily obtainable in the future after a Year Zero, and mortgages would be harder to get too, with a return to traditional lending standards of 20% down and a maximum of 33% of family income going to your mortgage, but would that be a bad thing?

A leader who proposed something bold like the above would be providing leadership. Our current so-called leaders... meh. So #4 on your list is currently getting a big fat zero from Washington D.C...

So anyhow, that's my response to your economics items. Note that I'm referring to postings that I made some time ago, that often refer to postings that I made some time before them, that address some small but important little pockets of modern economics theory. Next up, we talk health care...

- Badtux the Economics Penguin