Thursday, July 15, 2010

Am I violating DeLong's Law here?

Remember DeLong's Law:

  1. Paul Krugman is right
  2. If your analysis of the facts appears to show that Paul Krugman is wrong, see #1.
Paul Krugman states that helicopter drops of freshly-printed money are useless when the economy is in a liquidity trap. What he basically says is that the money will simply disappear under people's mattresses rather than being spent.

Is Krugman right? My initial thought was, "of course." But then I thought: But isn't unemployment compensation basically a helicopter drop of money to the unemployed?

At which point the lightbulb goes off. A helicopter drop can work even at the zero bounds where money typically disappears under mattresses if it addresses a population that has a nearly 100% propensity to spend -- i.e., those who are so desperate and short of money that they will spend the money on necessities (possibly deferred ones like replacing their unreliable 20 year old car with a "new" 10 year old car) rather than saving it. In other words, if you drop $100 bills out of a helicopter over the 4th Ward of Houston (a notorious ghetto), you can get extra spending in the economy and thus economic stimulus. If, on the other hand, you drop $100 bills over the posh Tanglewood or River Oaks subdivisions of Houston, it'll just disappear under mattresses (rather, disappear into banks as deposits, at which point it gets shoved under the Fed's virtual mattresses as reserves due to a lack of good investments for lending the money out). In other words, if you do like Bush's tax cuts did -- drop major chunks of money out of helicopters onto Tanglewood and River Oaks -- all you do is create an asset bubble as that money seeks mattresses to hide under. Which, err, is exactly what happened, doh.

So the next question is, how do you target those with the highest propensity to spend? Well, you could do it in a number of ways:

  1. Increase Food Stamp benefits (farmers will love you!)
  2. Increase unemployment benefits
  3. Increase Social Security benefits temporarily (since most Social Security recipients have a higher propensity to spend due to knowing that they'll always have Social Security thus don't need to save huge sums for a rainy day).
  4. Increase the Earned Income Tax Credit on a one-time basis to basically give a guaranteed minimum income of, say, $24,000 per year, to anybody who earns more than $6,000 per year, with an additional sum per child up to two children
And that's just off the top of my head. Every one of those ideas puts money into the hands of people with a high propensity to spend -- most of them are living from paycheck to paycheck, and have long-deferred needs such as dental care or a new car that they can spend the money on. So maybe the money will eventually end up under a mattress somewhere, but at least it'll do something before disappearing under the mattress. Not as much as if you spent it on things like, say, infrastructure, where the money could not be shoved under mattresses but rather had to be spent on things like steel and concrete and riggers and steelworkers and coal miners and etc., causing the money to ripple through the economy... but that would require that Obama propose additional stimulus, which in turn would require that Obama have a spine. I have seen no signs of that mythical feature of his anatomy.

Now, the next question is, can Ben Bernanke simply slip a check in the mail for every American? Paul Krugman says no, and suggests the Fed adjust its inflation target instead. But the Fed's inflation target, given that we're basically in deflation right now, is just a cruel joke. Whether Bernanke sets his inflation target at 3%, 4%, or 20%, people will just point and laugh. When you've hit the zero bounds, there is little the Fed can do to create actual inflation, because money freshly printed via, say, buying corporate bonds and Treasuries, will simply disappear under mattresses under the assumption that it will be worth more later as the currency continues to deflate or when the economy turns up and better investments are available. That's because that money is going to the investor class -- people with a lower propensity to spend and higher propensity to save (because they have more money than they need for their basic needs, as vs. the consumer class, which basically lives paycheck to paycheck and struggles to save the most basic of rainy-day funds). So if Bernanke announces an increase in the inflation target to 4%, all that will happen is that he looks like an idiot.

So I'm going to ask you: I'm disagreeing with Krugman on *TWO* things here. Am I violating rule #2 twice... or is Krugman violating rule #1 twice? Curious penguins want to know!

-- Badtux the Economics Penguin

6 comments:

  1. Of course, the questions ypu pose are academic since 1.)The majority of Dims have no balls to actually push through anything that would help paycheque-to-paycheque people, and 2.) The totality of Repigs have a truckload of brass balls devoted to pushing through anything that will destroy average Americans, just so they can gain some short-term tactical political advantage for the next couple of election cycles.

    Enjoy reigning over a failed state, motherfuckers! Let's see how you like it when anybody who still can afford to drive a new car will also have to pay for armouring it and having a posse of mercenary guards to protect you from the bricks and bullets directed at anybody who still has money.

    Aaaah, who am I kidding? Americans will accept it all like servile sheep, and direct all their killing power horizontally, instead of upwards against their "betters." But it will still suck to be the absolute king-shit rulers of a beat-down craphole Mexico Norte.

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  2. True enough, Bukko. Any useful helicopter drop would require that the Dems have a spine, and as with Obama himself, I've seen no signs of that mythical part of the anatomy when it comes to Democrats in Congress.

    And don't underestimate the attraction of "Mexico North" to the ruling class. I know a number of Indian professionals who have gone back to India after coming here to work for American companies for a while. I say "Why do you want to go back?" and they say "because even though it's a 3rd world hellhole with bad roads, unreliable electricity and phones, and few modern conveniences in the homes, I live the life of a king there." I.e., on a professional salary -- even one that's only half of what you get here in America -- he has servants, he has a driver for his car, etc. Don't underestimate the value that the owner class attaches to such things. Thus far our owner class has imported illegal Mexicans to fill that role, but that's been a rather, well, illegal, process fraught with problems, especially since the illegals have a bad habit of jumping ship and making enough money to go home and live like a king back home after a while, so having their own home-grown Mexican servants in the new Mexico Norte that they're making... dude. You can see the drool when you mention it to'em.

    - Badtux the Snarky Penguin

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  3. Re: the Mexico North thing - The ruling class is simply not very bright. (Someday, the revolution will come - in about 20 or 30 years, after right wing populism plays itself out.) If "investors" really knew what the hell they were doing, do you think almost all corporate effort would be on this quarter's statements, rather than some long range view? Besides, I've rubbed enough elbows with corp management to realize that there are many, many buffoons in boardrooms and corner offices.

    Which is why I think the Rational Eexpectations Theory and EMH are far, far from accurate representations of reality.

    Re: Krugman, I'm not sure you're disagreeing. The helicopter doesn't work in the liq. trap, and you agree on that. His post was devoted to the inability of the Fed to deal with deflation, while you're talking about targeted relief, which was not exactly on-topic for his post.

    BTW - I receive SS and pension, and it gets spent, 100%. I actually got paid for a gig last month (that is certainly novel) and immediately took the lovely wife out to dinner.

    Cheers!
    JzB the liquid trombonist

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  4. Uhm, actually, I do disagree with Krugman on the helicopter at zero bounds not working. If the Fed dropped a $1K check on your head, what would you do? Would you save it, or would you spend it on things you've been putting off for lack of money?

    Point being, you're part of a group with a high propensity to spend, and *even at the zero bounds* such groups *do* exist, and *will* generate economic activity if you put money into their hands. You just have to drop the money on the 4th Ward of Houston and Sun City in Arizona, not on River Oaks in Houston and North Scottsdale in Arizona.

    - Badtux the Disagreeing-with-Krugman Penguin

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  5. I can get you out of your first disagreement with these crucial sentences of Krugman's: "And we would expect people to save much or most of such a tax cut — all of it, if you believe in full Ricardian equivalence."

    Krugman does not say he believes in full Ricardian equivalence, so let's assume people would only save most of a cut (or helicopter drop). There are two ways of thinking of the money, first as a giant national payout and second as a bunch of individual ones. Taken individually, the idea that everyone would save most of their payout is unlikely for the reasons that you give: some will spend all of it while others will save all of it. Looking it as a blanket payout, though, you can still get some/much/most of it saved even as many/some people spend their whole thing. The question then would be whether there could be a targeted payout rather than a blanket one, and I don't think Krugman considered that. So it's not really a disagreement you have with him so much as a refinement the helicopter drop idea that makes it more useful.

    One thing though that should also be considered is that there are people, perhaps many (I am one), who wouldn't keep the money as savings, but neither would they spend it on economically useful things: they'd pay down personal debt, in spending money that was usefully spent long ago.

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  6. Indeed, on that last, I actually made that comment on another econo-blog. I.e., that the money would simply disappear into the banks and be shoved under (virtual) mattresses at the Fed for lack of productive things to loan it out for. But the thing is, using the money to pay down debt *does* cause increased consumption -- eventually. Because if you're not having to put out $200/month towards a credit card that you used your payout to pay off, you may put $100 of that towards *another* credit card that you're trying to pay off, but you're likely to spend a fair percentage of the money that had been going to the banksters as interest rents.

    In short, a $12,000 check in your mailbox used to pay off a $12,000 credit card bill that you're paying $350/month on wouldn't cause an immediate $12,000 in consumption. But you can figure at least $2400/year in consumption.

    In other words, this would be a horrifically inefficient way of increasing consumption, but it *would* increase consumption at least *some*. Krugman implies that there would be *no* increase in consumption, though.

    Of course, the "correct" way of handling this is to hand out money and *require* that it be spent. That means there will be at least one transaction before the money disappears under a mattress again. Even one transaction before disappearing under a mattress is better than *nothing*, and there are things the money could be spent on that would require *multiple* transactions before it disappeared under a mattress. But the only way we have to do that is government contracting for services such as, say, road construction or library expansion -- i.e., stimulus. Which would require Obama and the Congressional Dems to have a spine. Which, as far as I can tell, is a mythical part of the anatomy when talking about Obama and the Congressional Dems.

    - Badtux the Economics Penguin

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