John Maynard Keynes, in his book ‘Essays in Persuasion, ‘ foresaw the importance of a united Europe and tried mightily to reduce the penalties that the post World War I negotiations placed on Germany.  He was unsuccessful, in the end, so the penalties imposed were far too large for the defeated Germany, the result of which was to plunge the country into a Depression, ushering in the ultra nationalist movement and its leader Hitler.

J. Bradford DeLong, economics professor at UCal Berkeley, writes briefly about the current European Union banking woes and points out the current leadership is apparently ignorant of the lessons learned in the 1920s negotiations after WW I.

The 1919-1939 interwar period taught us four lessons:

1. In order for the world economy to be prosperous, adjustment to macroeconomic disequilibrium needs to be undertaken by both “surplus” and “deficit” economies–not by “deficit” economies alone.
2. If the world economy is to have any chance of avoiding or limiting crises, an integrated banking system requires an integrated bank regulator and supervisor.
3. In order for crises to be successfully managed, the lender of last resort must truly be a lender of last resort: it must create whatever asset the market thinks is the safest in the economy, and must be able to do so in whatever quantity the market demands.
4. In order for any monetary union or fixed exchange rate system larger than an optimum currency area to survive, it must be willing to undertake large-scale fiscal transfers to compensate for the exchange rate movements to rapidly shift inter-regional terms of trade that it prohibits.

I, at least, thought that everybody–or everybody who mattered in governing the world economy–had learned these four lessons that 1919-1939 had so cruelly taught us. Now it turns out that the dukes and duchesses of Eurovia had, in fact, learned none of them. History taught the lesson. But while history was teaching the lesson, the princes and princesses of Eurovia and their advisors were looking out the window and gossiping on Facebook….

Beezer here.  So pundits and politicians over here refer to how the US is going to end up like Greece because they are, simply put, uneducated twits talking to each other in a bubble.  A vast elaborate circle jerk of people who never learned the lessons of 1919-1939.  And it’s quite apparent never will.

Economic professors Bradford DeLong and Larry Summers have produced a paper, Fiscal Policy in a Depressed Economy, arguing that:

We are here to say that, as a matter of arithmetic, in a depressed economy like the present, if a long deep recession casts even a small shadow on future potential output, with interest rates in the range at which the U.S. has been able to borrow, there is a substantial likelihood that expansionary fiscal policy right now would be self-financing, and an overwhelming likelihood that it would pass a benefit-cost test.

The paper proposes a mathematical formula that, the authors contend, can gauge whether or not applying expansionary fiscal policies are worth the effort.  Using their formula, DeLong and Summers conclude we should have been using expansionary fiscal policies such as funding large infrastructure projects that would employ, literally, millions of people currently out of work, or severely underemployed given their skills.

Naturally, the paper has made quite a stir, and came under criticism from the Brookings Institution, a non profit think tank headquartered in Washington D.C.  In their response to Brookings, DeLong and Summers point out that Brookings did not criticize the paper’s mathematics, but rather questioned different assumptions in its application.

We were challenged on the proper estimate of the multiplier μ and challenged (quite rightly) on our guesses of the hysteresis parameter η, the share of a current downturn that is the shadow cast on future potential output. We were challenged by those saying that America’s debt capacity should not be used now but should be kept ready and dry to be used in some future crisis in which using it could do much more good than it would now. We were challenged by those who think that the U.S. is on the edge of losing not just its exorbitant privilege that allows it to borrow enormous amounts at negative real interest rates but is on the point of seeing a complete revolution in interest rates that will push the rates at which the Treasury can borrow up into high single or double digits.

But on our basic arithmetic we were not challenged: it is that fiscal policy in a depressed economy is self-financing as long as:

where r is the real Treasury borrowing rate–take the nominal Treasury borrowing rates and subtract 2%–g is the growth rate, which is 2.5%; τ is the fraction of GDP that shows up as increased tax revenues and reduced social-insurance transfers, which is 1/3; μ is the (debatable) standard Keynesian multiplier when monetary policy is at the zero lower bound; and η is the (largely unknown) hysteresis shadow a long, deep depression casts on future potential output.

As we, at least see it, it is possible to be highly confident that the depressed-economy standard Keynesian multiplier when monetary policy is at the zero lower bound μ is greater than 1.0, and substantially confident that the hysteresis shadow η cast by a long, deep depression is greater than 0.05.

The arithmetic means that over the past four years fiscal policy has been self-financing, and would be self-financing unless the real Treasury borrowing rate is rapidly going to become greater than 5%–unless the nominal Treasury rate is rapidly going to burst through 7% heading upwards. It has simply never been at such levels seven for a short span of years during and immediately after the Volcker disinflation.

Thus even if you think that the United States is on the edge of some kind of fiscal crisis and may be about to transit from a low interest rate “confidence in government” to a high interest rate “panic” equilibrium, increases in debt-service loads relative to GDP from fiscal austerity are more likely to shock the system into the bad equilibrium than are policies of fiscal expansion which over the past four years would–exceptionally and extraordinarily–have, for once, by the arithmetic, paid for themselves.

Beezer here.  This is all way to ‘wonkish’ for public discussion, of course.  But from our perspective the math being what it is, and it is not disputed, DeLong and Summer’s argument that we should have been much more aggressive with fiscal expansion in the aftermath of the 2008 financial meltdown seems accurate.   Oh well.  Inside baseball, I suppose.  There’s no way any Presidential campaign, on either side, wants to get down into the ‘weeds’ in public.  The public would simply be bored.   That’s so unfortunate because understanding our situation as it is, rather than what someone imagines it to be, is going to cost America dearly in the future.  We don’t need austerity.  We need to raise incomes and increase job growth.  The math is pretty clear to us that if we would just do these two things, we’d quickly be in a strong recovery.

Thomas Jefferson, one of the better known and most often quoted Founding Fathers, in a letter to James Madison, as written by Matthew Yglesias  at his blogsite here.

Thomas Jefferson is not my favorite among the founding fathers, but this 1785 letter to James Madison quoted by Daniel Kuehn is another good example of the non-libertarianism of classical liberalism:

Another means of silently lessening the inequality of property is to exempt all from taxation below a certain point, and to tax the higher portions of property in geometrical progression as they rise. Whenever there is in any country, uncultivated lands and unemployed poor, it is clear that the laws of property have been so far extended as to violate natural right. The earth is given as a common stock for man to labour and live on. If, for the encouragement of industry we allow it to be appropriated, we must take care that other employment be furnished to those excluded from the appropriation. If we do not the fundamental right to labour the earth returns to the unemployed. It is too soon yet in our country to say that every man who cannot find employment but who can find uncultivated land, shall be at liberty to cultivate it, paying a moderate rent. But it is not too soon to provide by every possible means that as few as possible shall be without a little portion of land. The small landholders are the most precious part of a state.

As with John Locke you see this concern about concentrated appropriation of finite resources. In practical terms, Jefferson and other leaders of the early Republic were able to sidestep inequality within the white community by redistributing land from Native Americans to white people.

Beezer here.  The internet does marvelous things.  I first went to Bradford DeLong’s site, which is  featured by economist’s view.  DeLong cited the above piece by Yglesias, who cited Daniel Kuehn because he found the quote.  I’m not an economist so I’m not certain of the relationship between modern libertarians and the Founding Father’s points of view.  All I found interesting was that Jefferson discussed redistribution policies with Madison.

Economics professor J. Bradford DeLong at UCal Berkeley, a former Under Secretary of Treasury under President Clinton, writes a straightforward argument for what the US should be doing to recover its economic momentum, and why political posturing gets in the way.  The nice thing about people like DeLong, Krugman, Galbraith, Thoma and many other economists is that their observations make so much sense.  They’re rational.  If you read them regularly, they often spend the time to delve into the data, and to cite historical events that shed light on what we’ve done wrong, and right in the past. 

In other words, they discuss issues the way such discussions are supposed to go.  That is not how discussions occur in our dysfunctional political arena.  Slogans and aphorisms substitute for data and logic.  Politics is not a search for the truth, it is combat for power.   Truth can help determine where power should reside, but our system no longer considers the idea that understanding the truth might help.  It’s pure power and if lies and dissimulation get you there, well that’s what you do.

“Politics is undermining our economy – The Week: There is a line of argument that I do not understand — even though it is made by economists I respect. It is that our current labor-market depression was baked in the cake from the moment that Alan Greenspan decided to keep interest rates low in the early 2000s, declining to stop would-be homeowners from borrowing from would-be mortgage lenders who were eager to lend. I disagree. I think that our current labor-market depression was baked in the cake when we started electing leaders who put other political and policy objectives far in advance of maintaining full employment.

Economist Dean Baker’s formulation of what I call the household-balance-sheet-recession argument goes roughly as follows: The housing boom created some $8 trillion of fictitious housing wealth — wealth that people thought they had because they believed they would be able to sell their homes at inflated prices. When housing prices collapsed, home owners realized that they were a lot poorer than they had thought. They cut back their spending on consumer goods by $1 trillion a year, and that is the source of our current downturn and high unemployment. With no way to recreate the $8 trillion of fool’s gold that was the housing bubble, there is no way to get American consumers spending again. So we were doomed to undergo this depression from the moment Greenspan failed to choke off the housing bubble.

But this argument seems wrong to me. Consumers are not the only spenders in the economy. Businesses can spend as well to boost their productive capacity — although it would be hard to get businesses to spend much to expand their factories if they don’t foresee the consumer spending to make those factories profitable. Exporters can lend money abroad to finance the purchase of U.S.-made goods and so pile up wealth in the form of money owed to us by foreigners. The government can borrow-and-spend, and if it spends wisely on human and physical infrastructure to boost our national wealth then it will have no problem repaying its debts in the future.

Yes, the collapse of the housing boom and the consequent $8 trillion reduction in household wealth does mean that consumer spending will be significantly below trend for quite a while to come. But when the consumer stops spending and sits down, the government and the exporter — and also the capacity-building business — can stand up: There is no chain of logical necessity leading from the collapse of the housing boom to a prolonged period of very high unemployment.

U.S. households want to save? Then let them save. And let businesses invest in productive capital, let the government invest in infrastructure, and let exporters invest in wealth claims abroad. The re-attainment and maintenance of full-employment, an a commensurate level of aggregate demand, should not be a problem as long as the federal government is willing to spend enough on building infrastructure and human capital, as long as the Federal Reserve can promise markets that it will keep real interest rates low enough for long enough to make building business capacity a no-lose bet, and as long as the Treasury is willing to let the value of the dollar fall far enough that America’s exporters can offer foreigners attractive deals on the goods and services we make.

Of course, if boosts to economy-wide spending led to inflation instead of increases in capacity utilization, then we would have a very big problem; we would be in the alternative universe of the Hayekians in which we have a fundamental mismatch between the skills of our labor force and the goods wanted by consumers. But there are no signs that we are in that alternative universe — no signs at all.

What, then, is our immediate problem?

It is political.

The Federal Reserve would rather let unemployment remain above 8 percent for a good long while than run the slightest risk of higher inflation. The Treasury would rather let unemployment remain above 8 percent for a good long while than say that a strong dollar is not in America’s interest (even though it is not). The Republican decision-makers in Congress would rather let unemployment remain above 8 percent for a good long while than let Obama win legislative victories.

Most puzzling, the Obama administration would rather let unemployment remain above 8 percent for a good long while than make what it thinks is likely to be an unsuccessful push that will reveal its lack of control over the government. Perhaps they are right that they have pushed the envelope as far as they can go with respect to Congressional action (although not as far as they could have with quantitative easing, loan guarantees or mortgage restructuring via the Treasury). But until you push, you do not really know. And back in the late 1940s Harry Truman welcomed the opportunity to run against the Republican Congress — to say that these were the policies he advocated, and he was sorry that the do-nothing Congress would not pass them. The Obama administration seems to feel differently: as if they dare not strip off the mask of competence and control to show the conflicted face beneath.

The current jockeying on competing budgets is yet additional proof of our political dysfunction. Our urgent problem right now is 9 percent unemployment. We need investment to speed productivity and income growth — and we need it soon. In the long run, we need to control health care program costs.

A game of budget chicken does not bring us closer to achieving these goals.”

Former Clinton Treasury economist, and now a Professor teaching at University of California, Berkeley, J. Bradford DeLong, authors a blog that I regularly read.  Like Krugman, DeLong has an insightful mind and the ability to pen articles that are understandable.  Like Krugman, he often laces his articles with humour.

What follows is a brief lecture by DeLong.  After that I quote a comment which I found almost as interesting as DeLong’s lecture.  Both deal with our current recession and the reactions from various groups to the effects of the recession.  Among them the Tea Party folks.  (I’ve also added a sadly funny cartoon)

“John Maynard Keynes once famously observed, “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” During the crisis years of 2007, 2008, and 2009, it was the great British economist himself, along with three other dead men, who dictated the world’s response from beyond the grave: Hyman Minsky, Walter Bagehot, and Milton Friedman.

Minsky, an economist at Washington University in St. Louis, for warning that times of financial calm and economic growth led banks to step further and further out onto the ice of leverage — until finally they would step too far and fall through. Bagehot, the 19th-century Economist editor, for advising that when the bankers fell into the ice-cold lake it was essential that the government spare no expense to make sure that the network of banking survived, but needed to do so in a way that took the bankers’ fortunes away. Friedman, the consummate monetarist, for seconding Bagehot’s call for bank rescues in depressions — and calling for central banks to keep the money flowing. And Keynes, for his gloomy fears that central banks would not prove powerful enough to do the job — coupled with his overoptimistic hope that clever technocrats could then boost government spending to take up the slack.

But we are now into the “recovery,” and 2010 has been a very different year. Its horsemen are of a different breed entirely. Where Keynes and his ilk were optimistic believers in the power of technocratic governments to do good, this year’s horsemen are practitioners of more dismal sciences: believers that the market metes out judgments that we must suffer — and that it is our own flawed nature that makes us believe so. In short, it has been a year for Austrian economists Friedrich von Hayek and Joseph Schumpeter, for plutocrat and Great Depression-era Treasury Secretary Andrew Mellon — and, above all, for Friedrich Nietzsche.

There was silence in the seminar room. Richard Kahn broke it. “Do you mean to say,” he asked, “that if I were to go out tomorrow and buy a new overcoat, that it would increase unemployment?”

“Yes,” said the man in the front of the room, Friedrich von Hayek, “but it would take a long and complicated mathematical argument to explain why.”

That is how historian Robert Skidelsky describes Hayek’s visit to the proto-Keynesian economists of Cambridge University. It was the 1930s, and Hayek had met them in London to convince them that depressions were not to be avoided or cured, but rather endured. In his thinking, they were righteous karmic payback for past sins against the gods of monetary orthodoxy. Any attempts to cut them short or make them shallower would produce only temporary palliation, at the cost of a fiercer, deeper, and nastier further depression in the future.

Hayek’s fellow countryman, Joseph Schumpeter, went further: “Gentlemen!” he announced to his students at Harvard University (there were no ladies). “A depression is healthy! Like a good ice-cold douche!” If depressions did not exist, Schumpeter thought, we would have to invent them. They were “the respiration of the economic mechanism.”

Agreeing with Schumpeter was Herbert Hoover’s Treasury secretary, Andrew Mellon. In his memoirs Hoover was bitter toward many, but bitterest of all toward Mellon, whom he called the head of the “leave it alone liquidationists.” Hoover quotes Mellon: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.” Hoover opposed Mellon’s policies, he said, and worked to undermine them. But what could he do? He was, after all, only the president. And Mellon was Treasury secretary.

Think Mellon is just an anachronism? Then consider current British chancellor of the Exchequer, George Osborne, and his claim that today’s record-low interest rates in Britain are a sign of financial strength and not of anticipated prolonged depression: “The emergency budget in June was the moment when fiscal credibility was restored. Our market interest rates fell to near-record lows.” That is pure Mellon. It is definitely not Keynes. It is definitely not even Milton Friedman.

Friedman himself condemned Hayek, Schumpeter, and Mellon as devotees of an “atrophied and rigid caricature” of his own doctrines. “[T]his dismal picture,” said Friedman, led “young, vigorous, and generous mind[s]” to recoil. And both Keynes’s and Friedman’s flavors of postwar American macroeconomics, with its focus on government action to maintain stable growth, were the happy result.

Nothing has changed in the past few years to make Hayek’s, Schumpeter’s, and Mellon’s arguments stronger intellectually against the critiques of Keynes and Friedman than they were 60 years ago. On substance, their current victory is inexplicable. But their triumph, epitomized by the Tea Party movement and its hostility to government action, can be explained by our fourth horseman: Friedrich Nietzsche in his role as psychologist of human ressentiment.

Nietzsche talked about the losers — or rather, about those who thought they were the losers. He looked at those who saw themselves as weak and poor — rather than strong and rich — and saw trouble. “[N]othing on earth consumes a man more quickly than the passion of resentment,” he wrote. It drives us to madness.

Think of that when you consider this: The U.S. unemployment rate is stubbornly high, yet aid from a federal government that can borrow at unbelievably good terms could allow states to maintain their levels of public employment, and those public workers would then spend their incomes and so boost the number of private-sector jobs as well. But the voters are against that. No, they say. We have lost our jobs. It is only fair that those who work for the government lose their jobs as well — never mind that each public-sector job lost triggers the destruction of yet another private-sector job. It’s the underlying logic that has led to a wave of austerity across Europe that is now headed for America’s shores. And it’s the same logic that says, “It is only fair that homeowners lose their money” — never mind that everyone’s home prices will suffer. What does not kill me makes me stronger.

Because some are unemployed, unemployment is good — we need more of it. Because some have lost their wealth, wealth destruction is good — we need more of it. That is a psychology that Friedrich Nietzsche would have understood all too well. For, as he put it, “If you gaze long into an abyss, the abyss will also gaze into you.”

Beezer here.  As you might expect, the lecture drew a string of thoughtful comments, some critical about DeLong’s use of quotes.  But one commentator, mg, weighed in with some observations that I found plausible and corresponded with my own experiences.

“ Delong’s description of what drives them IS perfectly rational. They derive a great deal of psychic income from being roadblocks, from frustrating other people through their passive-aggressive refusal to allow action. There are more reasons than just this, but I think it’s a large animus for the movement.

There are ignorant people who are motivated by simple slogans, like “You can’t use debt to solve problems caused by too much debt.”

There are tribalists who are, a priori, against anything proposed by “liberals.”

There are plutocrats (and their hirelings) who are doing very well under current circumstances, thank you very much, and absolutely don’t want the government, which is in disrepute, to gain any credibility by solving problems created by plutocrats. If that happens, government might actually gain the ability to take action, like regulation that will stop them from looting the system.

And there is a large cohort of people, 50+ years old, generally doing OK economically, who are being discarded by the system, whatever dreams they had unrealized, and who are seething with anger at resentment about it, and see nothing wrong with taking that anger out on other people, even if they don’t consciously realize that’s what they’re doing.

I know the first and last cohort quite well, because I interact with them on a daily basis. And I can, after one minute of conversation with one of them, figure out which camp they belong in. Both groups of people are perfectly nice and pleasant, until they start talking about the economic situation. The angry people can’t discuss it without angrily and bitterly denouncing others. They usually have a scapegoat, like the government, and I’ve heard Arabs used several times (75 years ago it would have been the Jews). And they are totally uninterested in rational discussion: the government caused this, the government can’t fix it, end of story. I used to think it was because they’d spent most of their adult lives listening to Rush Limbaugh, and had been brainwashed into believing the government can’t do anything right, but it never explained the anger to my satisfaction. Delong’s explanation does (it also, at least somewhat, explains why people would spend the majority of their adult lives listening to Rush Limbaugh et al, but that’s another topic).

I agree that it’s oversimplifying to a degree, but I think he nails an important motivator for what is seemingly irrational behavior. The one thing I’m not sure Delong realizes is that most of these people are actually OK economically. Sure, they’ve lost, or are in danger of losing, their jobs, but they’ve been pretty prudent, and socked away a fair chunk of change, plus they’ve usually paid off their houses, and are either getting SS + Medicare, or are in striking range of it. They can afford to indulge in this sort of behavior, even if they’d rather not have to.”

Beezer.  These explanations for the reactions of various groups are interesting.  But as with any such observations, it’s all opinion.  Tea Party supporters no doubt contain members that don’t fit well into any of the categories addressed here.  We are not uniform, after all.  And even within groups that are easy to identify in the main, under the surface are many important differences.  

J. Bradford DeLong, an economist at UCal Berkeley and former Treasury official with Clinton, raises some economists on their own petard with an article entitled ‘Economics for Parrots’ published at Project Syndicate.

Economists know the rules of supply and demand but seem to have forgotten them recently, DeLong says.  The parrot analogy came from a quote by British economist J.R. McCulloch who said that the only training a parrot needs to be a passable political economist is one phrase: “supply and demand, supply and demand.”

“….economics would be useful if economists were, indeed, likeMcCulloch’s parrots – i.e., if they actually looked at supply and demand. But I think that much of economics has been discredited by the manifest failure of many economists to be as smart as McCulloch’s parrots were.

Consider the claims – rampant nowadays in the US – that further government attempts to alleviate unemployment will fail, because America’s current high unemployment is “structural”: a failure of economic calculation has left the country with the wrong productive resources to satisfy household and business demand. The problem, advocates of this view claim, is a shortage of productive supply rather than a shortage of aggregate demand.

But it should be easy – at least for an average parrot – to tell whether a fall in sales is due to a shortage of supply or a shortage of demand. If a fall in sales is due to a shortage of demand while there is ample supply, then, as quantities fall relative to trend, prices will fall as well. If, on the other hand, the fall in sales is due to a shortage of supply while there is ample demand, then prices will rise as quantities fall.

Which do we see now? There are no places in the US economy where wages or product prices are rising more rapidly than expected. There are no places where a shortage of qualified labor or of available capacity is sufficiently great to induce managers to pay more than they have been used to paying for good hands or useful machines.”

And DeLong says these economists are getting another policy response wrong because they, despite their claims to pay attention to supply and demand, apparently aren’t. 

“Or consider the claims – also rampant these days – that further government attempts to increase demand, whether through monetary policy to alleviate a liquidity squeeze, banking policy to increase risk tolerance, or fiscal policy to provide a much-needed savings vehicle, will similarly fail. These measures, too, are supposedly doomed because they all involve increasing governments’ liabilities, and financial markets are at a tipping point with respect to sovereign debt. If governments that have already tapped-out their debt-bearing capacity now issued more debt or money or guarantees, they would deal a mortal blow to confidence.

Once again, an adequately trained parrot, unlike many economists nowadays, would ask whether the economic problems that current levels of government debt are causing reflect too much public debt supplied by governments or too much public debt demanded by the private sector. If the problem were that supply is too great, then new emissions of government debt would be accompanied by low prices – that is, by high interest rates. If the problem were that demand is too great, then new emissions of government debt would be accompanied by high prices – that is, by low interest rates.

Guess which one the US and many other countries have? For a parrot, that’s a no-brainer: the public-debt problem is not that governments have issued so much debt that investors have lost confidence, but that governments have issued too little debt given the enormous private-sector demand for safe places to park wealth. The problem, the parrot would say, is that households and businesses are still trying to build up their stocks of safe, high-quality assets, and are switching expenditures from buying currently-produced goods and services to increasing their shares of an inadequate supply of government liabilities.”

DeLong wonders what future historians will ask when they look back on today’s debates over whether or not the federal government gave the American economy too much, or too little.

“When economic historians examine the Great Recession, their overwhelming consensus is likely to be that its depth and duration reflected governments’ refusal to try to do more, not that they tried to do too much. They will agree with the parrots that falling inflation showed that the macroeconomic problem was insufficient demand for currently produced goods and services, and that the low level of interest rates on safe, high-quality government liabilities showed that the supply of safe assets – whether money provided by the central bank, guarantees provided by banking policy, or government debt provided through deficit spending – was too low.

The question that will be a mystery to them is why so many economists of our day did not know how to say: “supply and demand, supply and demand.”