Triangulating on deficit reduction, 2010 version

As I indicated in my post Grading Obama’s economic policy after one year, I see the President as a triangulating center-left politician of the Bill Clinton variety. The reason we have seen public policy which has been favorable to big business and reactive to events on the ground during this economic downturn owes much to this.  And, as if he heard me and wanted to prove me right, we get this just days later via the New York Times:

President Obama will call for a three-year freeze in spending on many domestic programs, and for increases no greater than inflation after that, an initiative intended to signal his seriousness about cutting the budget deficit, administration officials said Monday.

The officials said the proposal would be a major component both of Mr. Obama’s State of the Union address on Wednesday and of the budget he will send to Congress on Monday for the fiscal year that begins in October.

The freeze would cover the agencies and programs for which Congress allocates specific budgets each year, including air traffic control, farm subsidies, education, nutrition and national parks.

But it would exempt security-related budgets for the Pentagon, foreign aid, the Veterans Administration and homeland security, as well as the entitlement programs that make up the biggest and fastest-growing part of the federal budget: Medicare, Medicaid and Social Security.

I’m not sure who the White House thinks it can fool but the last paragraph makes clear that there is no long-term thinking in this public policy. If you want to go long-term and substantive on deficit reduction, you have to address military spending, Social Security, Medicare, and Medicaid. Everyone knows that.

Last summer I said:

the United States faces a very large fiscal problem under present tax and spend scenarios given likely future growth outcomes.  In plain English: there is a gigantic hole in the U.S. Government’s balance sheet under normal GAAP accounting…

SocialSecurityandMedicare[1]

The problem, of course, is Medicare and Social Security.  Looking again at 2007 and the composition of spending (Chart of the day: US federal spending and receipts), one can see that 40 percent of the budget went to spending on Medicare/Medicaid and Social Security…

These unfunded liabilities fit into today’s policy debate in that reducing Social Security and Medicare benefits would not only eliminate structural budgetary problems, it would also allow Obama to demonstrate fiscal prudence – even while the present deficit balloons.  I guarantee you that Summers, Geithner, Orszag and Romer are on to this and that this is a debate of huge importance inside the Administration.

These are tough issues politically. If the debate was happening in the Obama Administration, those favoring short-termism won it. And if you think Obama doesn’t get it, read Barack Obama gets it where he outlines the issue just one month ago.

See this chart from Perot Charts?  I originally posted this in June of 2008. You can see where the largest budgetary items are.  They are not in domestic discretionary spending where Obama is cutting.  So what gives?

challenges21-640[1]

I think Ryan Avent has it right when he says:

There really is no good way to interpret this turn of events. From the standpoint of the purely economical, this is a huge mistake. Even if we assume that the economy will be strong enough in 2011 to handle budget balancing, this proposal is practically worthless. The administration has said this will produce $250 billion in savings over ten years, but as The Economist noted in November, the fiscal deficit will be over $700 billion in 2014 alone, and will grow from there. Non-defence discretionary spending is nothing; those who are serious about long-term budget sustainability talk about defence, they talk about entitlements, and they talk about revenues. In other words, this will do very little about the deficit, and it will do even less to convince markets of the credibility of the American effort to trim the deficit.

So perhaps this is all about politics? Well, maybe, but there are two enormous problems with that. One is that the campaign trail version of Barack Obama railed against John McCain’s proposal for a spending freeze, rightly, as using a hatchet where a scalpel was needed. It’s unlikely that Mr Obama’s political opponents will let him forget that. The other is that this is a complete betrayal of the political ideal Mr Obama seemed to espouse from the beginning of his political career—the rejection of the argument by the lowest common denominator in favour of a more reasoned and argued approach. This is yet another move toward the infantilisation of the electorate; whatever the gamesmanship behind the proposal, Mr Obama has apparently concluded that the electorate can’t be expected to handle anything like a real description of the tough decisions which must be made. I sympathise with Mr Obama’s position—would that American voters were patient enough to hear and consider a detailed policy discussion on a complex issue—but it’s unreasonable to expect that Americans can be hoodwinked into major policy shifts.

Hoodwinked is a good word. The free dictionary defines hoodwinked:

hood·wink (hdwngk)

tr.v. hood·winked, hood·wink·ing, hood·winks

  1. To take in by deceptive means; deceive. See Synonyms at deceive.
  2. Archaic To blindfold.
  3. Obsolete To conceal.

hoodwink [ˈhʊdˌwɪŋk]

vb (tr)

  1. to dupe; trick
  2. Obsolete to cover or hide

hoodwink

verb deceive, trick, fool, cheat, con (informal), kid (informal), mislead, hoax, dupe, gull (archaic), delude, swindle, rook(slang), bamboozle (informal), take (someone) for a ride (informal), lead up the garden path (informal), sell a pup, pull a fast one on (informal), cozen, befool Many people are hoodwinked by the so-called beauty industry.

So, this is a deception where the White House is attempting to fool us that it cares about deficit reduction. We are being taken for a ride, bamboozled, if you will.

But, as Ryan has suggested, voters are on to this con – as evidenced by my recent poll. There is widespread disappointment in this approach from economic pundits. 

Brad DeLong, a big Obama supporter, says:

Barack Herbert Hoover Obama?

pointing to the potential this has of worsening the economic scenario. As I have been saying, Obama’s deficit measures – short-term measures that do not address systemic issues – are why I see double dip.

Mark Thoma says:

This is pretty disappointing.

The long-term budget problem is due to primarily one thing, rising health care costs. Everything else is dwarfed by that problem. If we solve the health care cost problem, the rest is easy. If we don’t solve it the rest won’t matter…

we get cheap political tricks that are likely to backfire. How will this look, for example, if there’s a double dip recession, or if unemployment follows the dismal path that the administration itself has forecast?

Obviously, I agree with Thoma’s later comments suggesting that Obama is playing Bill Clinton, having said:

I believe Obama is a triangulating New Democrat. His kneejerk reaction, therefore, is to look back to 1994 and draw the same conclusions Bill Clinton did when his own healthcare agenda collapsed. And all of the Clintonites surrounding him in the White House bubble are no doubt convincing him to do this. But 2010 is not 1994. Barack Obama would be well-advised to understand this.

All sorts of comparisons to past Presidents are being made. May I suggest that while Obama is playing Bill Clinton, he is actually Jimmy Carter. The “Crisis of Confidence” or “Malaise” speech Carter gave in 1979 when his administration was on the ropes was widely praised (see transcript here). But it was followed by his inexplicable request for the resignation of every member of his Cabinet.  From then on, his presidency was doomed.

Source

Obama Seeks Freeze on Many Domestic Programs – NYTimes.com

Also see Chart of the day: Social Security and Medicare and Rahm Emanuel, Obama’s Chief of Staff, Draws Fire From Left for background on the economics and politics respectively.

13 Comments
  1. Zac says

    Ed it’s off topic but, in Keynesian way if you want to start economy you have to permanently employ the unemployed (middle and lower class, because they bring bulk of demand), and raise general level of wages it would bring healthy demand (or inflation) and more important it would bring down general level of indeptedness…
    So how to achieve that is mi. $ question? Stim. II, for average joe?
    Another way is just to bring down general level of indeptedness and it is very painful path…
    Generally, global wages mismatch is most dangerous problem in Economy throughout history…

    1. Edward Harrison says

      That is very much on topic. You have two options: increase aggregate demand or decrease it.

      https://pro.creditwritedowns.com/2009/10/the-choice-is-between-increasing-or-decreasing-aggregate-demand.html

      In either case, the key to recovery is liquidating excess capacity and malinvestment.

      You’re not going to get a lot of spending multiplier from stimulus if banks are capital constrained and businesses and individuals are indebted. Debts must be liquidated and that means private sector deleveraging.

      In my view, the difference between the two scenarios is the degree to which you believe government can help in cushioning the deleveraging blow. In the Austrian case, you risk a downward spiral that has nasty political and foreign policy implications (think Mazlow’s Hierarchy of needs in action). In the Keynesian case, you have government spending money and wasting some of it or propping up bankrupt institutions.

      Either way, your questions are the right ones.

      1. Marshall Auerback says

        there is no such thing as a “money multiplier” which is an old gold standard concept.
        In the real world banks make loans independent of reserve positions, then during the next accounting period borrow any needed reserves. The imperatives of the accounting system, as previously discussed, require the Fed to lend the banks whatever they need. Bank managers generally neither know nor care about the aggregate level of reserves in the banking system. Bank lending decisions are affected by the price of reserves, not by reserve positions. If the spread between the rate of return on an asset and the fed funds rate is wide enough, even a bank deficient in reserves will purchase the asset and cover the cash needed by purchasing (borrowing) money in the funds market. This fact is clearly demonstrated by many large banks when they consistently purchase more money in the fed funds market than their entire level of required reserves. These banks would actually have negative reserve levels if not for fed funds purchases i.e. borrowing money to be held as reserves. If the Fed should want to increase the money supply, devotees of the money multiplier model (including numerous Nobel Prize winners) would have the Fed purchase securities. When the Fed buys securities reserves are added to the system. However, the money multiplier model fails to recognize that the added reserves in excess of required reserves drive the funds rate to zero, since reserve requirements do not change until the following accounting period. That forces the Fed to sell securities, i.e., drain the excess reserves just added, to maintain the funds rate above zero. If, on the other hand, the Fed wants to decrease money supply, taking reserves out of the system when there are no excess reserves places some banks at risk of not meeting their reserve requirements. The Fed has no choice but to add reserves back into the banking system, to keep the funds rate from going, theoretically, to infinity.
        In either case, the money supply remains unchanged by the Fed’s action. The multiplier is properly thought of as simply the ratio of the money supply to the monetary base (m = M/MB). Changes in the money supply cause changes in the monetary base, not vice versa. The money multiplier is more accurately thought of as a divisor (MB = M/m).
        Failure to recognize the fallacy of the money-multiplier model has led even some of the most well- respected experts astray. The following points should be obvious, but are rarely understood:
        The inelastic nature of the demand for bank reserves leaves the FED no control over the quantity of money. The FED controls only the price.
        The market participants who have a direct and immediate effect on the money supply include everyone except the FED.

        In a message dated 26/01/2010 Mountain Standard Time, writes:
        ======

        Edward Harrison wrote, in response to Zac (unregistered):

        That is very much on topic. You have two options: increase aggregate demand or decrease it.

        https://pro.creditwritedowns.com/2009/10/the-choice-is-between-increasing-or-decreasing-aggregate-demand.html

        In either case, the key to recovery is liquidating excess capacity and malinvestment.

        You’re not going to get a lot of spending multiplier from stimulus if banks are capital constrained and businesses and individuals are indebted. Debts must be liquidated and that means private sector deleveraging.

        In my view, the difference between the two scenarios is the degree to which you believe government can help in cushioning the deleveraging blow. In the Austrian case, you risk a downward spiral that has nasty political and foreign policy implications (think Mazlow’s Hierarchy of needs in action). In the Keynesian case, you have government spending money and wasting some of it or propping up bankrupt institutions.

        Either way, your questions are the right ones.

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        1. Edward Harrison says

          I’m not talking money multiplier but spending multiplier in the sense it
          increases the marginal propensity to take on credit.
          ______________
          Edward Harrison
          https://pro.creditwritedowns.com/

        2. Edward Harrison says

          My point is that government spending can have a multiplier effect in increasing aggregate demand such that it decreases economic distress. This should increase the marginal propensity to take on credit. It should also alleviate supply side concerns about creditworthiness of borrowers.

    2. Edward Harrison says

      Just to be clear, right now the problem is debt.

      I am saying that additional government spending increases the creditworthiness of borrowers who would otherwise be deleveraging. As a result, it reduces both supply side and demand side credit constraints by increasing actual income of potential borrowers and increasing the marginal propensity to lend because of lenders’ perception that borrowers’ creditworthiness has increased.

      This is where a spending multiplier should come in. Martin Feldstein has been saying the debt constraints are so great that they cannot be overcome.

      1. Marshall Auerback says

        PRIVATE debt, not public debt.

        1. Edward Harrison says

          Agreed. But more than private sector debt, it is household sector debt that concerns me. We need to differentiate between the financial and corporate sector and the household sector. That is where a spending multiplier can be beneficial.

Comments are closed.

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