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October 02, 2009



Reich Laughed At For Saying Stimulus 'Keeping People Employed'

jj mollo

I mean, how do you know it was wasted? There's a serious argument over the whole idea of stimulus spending in academia. I'm talking about serious people who have spent their lives studying the issue and debating other academics. No punches are pulled in this conversation, and they both have good points. There are two groups of academics, basically known as the freshwater and saltwater economists. Saltwater economists are represented by more liberal schools on the east and west coasts, Harvard, Princeton, UPenn, Berkeley. Freshwater economists favor UChicago and UMinn. The difference centers around their philosophical reaction to Say's Law, which essentially implies that the Market knows what it's doing. The freshwater guys tend to agree. Milton Friedman was the most persuasive exponent of this position. His dictum was "only money matters". He wasn't willing to say we could do entirely without market oversight, but he believed that the optimal approach is for the Fed to make sure that money stays at a steady level, restricting it when inflation threatens, loosening when unemployment grows. And his viewpoint has generally been in control for the last 30 years. The really good thing about monetary control is that it is fast.

The saltwater school does not accept the benevolence of Mr. Market. The particular weaknesses, most appropriate today, are the failures of macro-economics to account for herd behavior, for large-scale irrationality, for bubbles, collapses and the Great Depression itself. Saltwater theorists generally accept the freshwater innovations, but they are politically inclined to say, the optimality of markets grinds too slowly for mere mortals. The gaps have to be filled somehow to prevent the worst of the transition pains. Not all of them even believe that market forces are immune to self-immolation, considering complete social collapse a possible outcome of laissez faire approaches.

My own feeling is that markets are very powerful for providing the correct economic solution, but that humans spend a lot of effort trying to suppress the market, outwit the market, or redirect the market in order to get rich quick. When massive amounts of wealth have been directed into corrupt or inappropriate economic activity, bad things can happen, and sometimes suddenly. Feedback loops are brutal. Usually, the government has rescued us from financial collapses by herculean behind-the-scenes intervention, forcing institutions to do what was best for them, sometimes against their wills. How many times, in the old days, did groups of financiers, and even single individuals, save the banks and/or stock market from disaster. Nobody thinks about that because they don't have to. Ignorance is bliss. But the financiers themselves did not sleep so easily at night. They were able to imagine the potential consequences that others were spared the knowledge of.

Occasionally we get ourselves into such a fix that nothing the government does can prevent a broad economic impact. This time, and before in 1929, the collapse shriveled the money supply to a destructive extent. In 1929, ignorance prevented appropriate action. This time we were incapable of taking effective action because of two persistent mistakes. The Federal deficit was already growing fast, in the middle of a boom, and the low interest rates were feeding the beast. When the money supply collapsed and mass financial behavior became abruptly more conservative, there were no reasonable measures left. The freshwater guys were saying, prepare to suffer the Market Justice in this best-of-all-possible worlds, and Obama had to pick his advisors in this environment. He was probably naturally disposed to select the more liberal school, but he really had no choice but to pick people who thought they could address the problem. Things were getting grim. They still are.

Unemployment numbers do not show the full extent of the problem. There've been a lot of early retirements and discouraged workers. Take a look at these percent employment numbers. You can get a pretty dramatic graph by choosing appropriate options at the bottom of the page.

Is it better than it would have been without the stimulus spending? Before you answer, ask yourself, are you really sure that you know how bad it can get?

jj mollo

Keynesian theories are more counter-intuitive than classical economics. The average person might be inclined to laugh at some of the ideas, but that doesn't make the ideas wrong. Reich is short and kind of funny looking. Lots of people who know what they're talking about are short or funny-looking. I'm six foot and stunningly handsome. Does that make me right about everything?

jj mollo

Here's another dramatic graph posted here in May that shows the size of the financial emergency. Do you think there is a connection between the two graphs?

Frank Warner

Backing up the banks was one thing. That was necessary, and, in fact, it wouldn't have cost anything if the banks came back quickly.

But these "serious people" who claimed to know what they were doing with the hodgepodge, thoughtless $787 billion "stimulus" package have been exposed as fakes.

The numbers are there. When you're talking about the unemployment rate, there's a huge difference between 7.8 percent and 9.8 percent.

Claiming to know what they were doing, they said we'd be at 7.8 percent. Now we know they can't claim to know what they were doing.

jj mollo

How have they been exposed as fakes? That's an extravagant assessment. The unemployment estimate was wrong. So what. Economics is not an exact science. Uncertainty prevails. It takes us three tries to get the GDP measurements down correctly. Measurements are difficult. Proxies are not well targeted. Economics is difficult and uncertain. It's also hard to determine whether any economic policy ever works because you never get to go back and do it again another way.

The hodgepodge is definitely there, but that happens when you put things through Congress. It's actually a feature, though, not a bug. Diversity of investment is an important principle and it applies equally to stimulus spending.

And are you really doubting that there are some serious economists who believe strongly that fiscal stimulus works? Every economic forecast is wrong as soon as it's printed. That doesn't necessarily reflect badly on the forecasters any more than it does with the weather report. The system under study is complex and incompletely understood.

Frank Warner

Certainly all that spending accidentally helped someone somewhere, at least temporarily.

But I am concerned that the "stimulus" and bailouts were so poorly targeted and ill-designed that they have favored doomed industries and pushed the economy in an unsustainable direction.

The "plan" assumes the U.S. can handle high-paid union workers at GM and Chrysler, and the U.S. can handle alternative energy that costs five to 10 times more than conventional fuels that everyone else in the world will continue using.

What a plan like that ends up doing is upsetting the economy more, because, once the "stimulus" is over, businesses have to pull out of the illusion and respond to the real world. If we've put all our eggs in an overpriced basket that the world tosses aside, we've wasted a lot of borrowed money on nothing.

jj mollo

That's true enough. Those are legitimate concerns. Bailing out the auto industry was only temporarily necessary. It's the timing of these things that matters. Next year the auto industry can go fish, but today we can't endure a flood of unemployed workers out on the street.

Infrastructure is the safest investment because you know that it's not a mistake and it represents a form of saving that doesn't reduce the money supply. Our children don't have to worry about the bridges we fix today. Targeted industrial development is good as long as you're pretty sure you know what you're doing. You can't be throwing a lot of money at dying industries unless you have no choice. Defense spending in the form of weapons procurement is fairly safe, especially high tech stuff. It's unlikely that the need for defense is going to taper off any time soon. The spending on such projects tends to be spread around more and the spinoffs are good.

Unfortunately, the Republicans, who generally support infrastructure and defense spending, missed their opportunity to focus the spending in these areas. Basically, they had lost the Keynesian vs. Friedman argument. The stimulus bill was going to pass. Why not make something useful of it? They could also have insisted that part of the "Green" spending be directed toward nuclear power. That would have been a battle worth fighting.


I get the feeling that you are a Keynesian believer, jj :). I love this comment: "Keynesian theories are more counter-intuitive than classical economics. The average person might be inclined to laugh at some of the ideas, but that doesn't make the ideas wrong."

That's fair enough, but it ignores the root of Keynes' idea of having the government create short-term stimulation of a sluggish economy. As we saw with the stimulus porkulus package, and every other time this theory has been tested, is that -shock!- the politicians who spend the money are less concerned with stimulating the economy than they are about paying off crony debts. They don't vote to spend money effectively, and THEY NEVER WILL. It's not in any politicians self-interest to do so. That's why our job as non-politicians is to minimize the amount of money that politicians can spend. FWIW we're pretty lousy at our jobs.

The reason Keynesian economics don't work is the same reason that socialism and communism don't work. People act out of self-interest, not group-interest. This is especially true of politicians.

Frank Warner

I don't think the Democrats really were listening to Republicans earlier this year anyway, but yes, the Republicans could have made a clearer argument that what you spend money on matters -- that if you're going to spend, you might as well spend it on something you need.

Still, it probably would have been useless to ask Democrats, high on their new power, to suddenly support defense and nuclear power.

"Regime uncertainly" remains a huge obstacle to mending this economy. And the more our government rocks the boat against constructive free market forces, the longer our recovery will take.

jj mollo

Leaders don't always act completely in their own self-interest. They can find a compromise between self-interest and collective interest. Win-win is possible when people decide to work together. And they must be doing it on occasion because I have actually seen workers repairing potholes. Usually they fill the potholes in front of the mayor's house first, but they do fill others as well. Infrastructure work happens. Year after year it gets added to the budget. Often infrastructure funds get raided for something else, but never drained completely.

"Regime uncertainty" refers to distrust in the underlying rules of the economy. Theoretically people won't invest when they feel that their property will be confiscated, or tax rules will be arbitrarily changed to undermine their investment. There is something to that. Who's investing in Venezuela now? Russia and China -- investors who can enforce their own rules, who also accrue a strategic benefit. The US has indeed lost some gound in that area since Obama's election, perceived quality of the business environment. The business report I saw said we had moved from number one to number two. In the World, that is. Not bad for a "socialist" government in the midst of a financial emergency!


In fairness, jj, we're not socialist yet. Most of BHO's socialist agenda hasn't passed Congress. In fact, his nationalization of GM may help to thwart his efforts to socialize America. We can only hope.

And yes, leaders DO always act in their own self-interest. That's why the potholes get filled by the Mayor's house first. Yours MIGHT get filled too while they're at it, but only so they can self-interestingly get enough votes to get re-elected. I suspect that you know this, deep down.

As Orwell once said:

Government Baaaad
Free Market Gooood

(It's not common knowledge that he said this because he said it to me once when no one was around. Trust me, I wouldn't lie to you.)

jj mollo

If the Free Market can do the job, then I'm all for it. And that's true most of the time, given the right incentives. But it takes some oversight to make sure the incentives are right, and there are other market failures that need watching as well. The government should be to business as a small jockey on a big horse. You don't want to be a burden, but it just doesn't work right if one of the parties is missing.

Frank Warner

I don't look at government and business as a jockey and a horse. Business is the jockey and the horse. Government might be the track keeper and the judge.

Possible social science study: Ask 100 people who or what at a horse race track represents government and who or what represents business. Then look for philosophical and political correlations.


"Imagine continually explaining that markets function because they have a built in corrective mechanism; that periodic contractions are necessary to weed out unproductive ventures; that continually loosening credit to avoid such corrections just puts off the day of reckoning and inevitably leads to a larger recession; that this is precisely what the government did during the 1920's that led to the great depression; and then, when the recession hits, seeing it offered as proof of the failure of laissez-faire capitalism."


We see things a little differently, jj, and always will. I think the government should be to business what the planet Earth is to the galaxy Andromeda. Completely unrelated and uninvolved in each other.

jj mollo

The problem is that government is always involved in business and business is always involved in government. Because of that, things get screwed up. Businesses are always lobbying for special tax breaks and government projects. Government tries to ameliorate the conditions of people in order to influence elections. Government modifies business in order to pursue other objectives, like homeland security, foreign wars, or appeasement of petroleum suppliers ... or more broadly, strategic concerns. Businesses otoh are constantly seeking new and inspired ways to evade regulations, avoid taxes, restrict competition or increase barriers to entry.

These two agencies work together hand and glove to distort the "natural" development of competitive enterprise. And they pursue these ends without resort to concepts of simplicity or balance, and, at least on the government side, without a whole lot of economic competence. If, however, they were, by some miracle, to cease and desist and become model capitalists, a howl would go up in all parts of the country that could not be silenced. It's a mutual con game. Everybody wants their piece of the action. So you can give up the Utopian dream that pure market capitalism will solve all our problems. Our only hope is to rein in the worst of the troublemakers and keep some water around to put out any fires.

The main advantage of unanticipated recessions is that they shock the regulators, who suddenly get religion. Economic distortions can be explained by the joint action of runaway human emotions and counterproductive government policies. Why doesn't government or business act to normalize the situation. Any idiot on Main Street can see when a bubble is forming. Businesses can't do anything about it because they're too busy making hay from it. And that's also why government doesn't do anything about it. They are essentially paid to look the other way. And who want's to be the party-pooper anyway? Nobody feels the need to correct the situation until they wake up with a headache the next morning.

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