I have a ritual on Sundays: Like a nasty highway crash, I can't help but look at the opinions of politicians, both Republicans and Democrats, being presented for the nation to see on the talk show circuit.
So when I saw Rand Paul's pro-austerity stump speech yesterday on Candy Crowley's State of the Union show on CNN, I cringed as my eyes and ears were peeled to his comments that "the sequester is merely a pittance." This is an extension of the promotion by Republicans of the meme that "Spending Is the Problem!"
If he thinks the sequester is merely a pittance, that must mean Rand Paul really wants hardcore Paul Ryan style austerity. To support this, he repeated a talking point that he has pumped out there for years now, insisting that the national debt is costing a million jobs a year.
This is based on the flawed idea that the conservative think-tank AEI has been supporting in its press releases. It cites a Reinhart Rogoff study of dozens of economies historically, which suggests that, in general from their sample, growth slows after national debt exceeds a certain level. This is merely an empirical observation of a number of economies that have very different underlying fundamentals and composition. than that of the United States. Beyond that, at issue is the causality vs. correlation. The slow growth in the US came because of a major bubble bursting, not from piling on of debt. In fact, debt has shot up due to spending to help address the fall in GDP, and has helped enormously in that area. The negative effect on growth was already there before we crossed the magic 90% threshold cited in Reinhart & Rogoff, so the suggestion by the AEI that this is a causal relationship that lives on and affects us today is downright wrong.
That slow growth translates to lost jobs is not what is being disputed. The growth/employment correlation is a fairly strong empirical relationship. This point is uncontroversial, but the R&R study is where the details get dirty. To take an empirical observation of non-monetary sovereigns and make untrue causal links for the American debt situation to high unemployment is dishonest.
There's lots of criticism of the Reinhart/Rogoff study, which has caused the two authors initially to soften and then later even change entirely their claims from there being a causal relationship to there being a mere correlation, which tends to break down actually for systems that have fiat sovereign monetary systems. Paul Krugman has been instrumental in pointing out the shortfalls of their initially strong claims.
But these revelations don't change the tone of a right-wing think-tank like AEI. They will continue to misinterpret studies to push their anti-government agenda despite retractions/clarifications from authors of the studies.
No surprise there, Rand Paul is citing bad science to support bad policy. We know that the debt isn't what is causing the current slow growth. Instead, the culprit is clearly the financial crisis leading to destruction of aggregate demand that was caused by irresponsible bank behavior in an environment of deregulation supported by Reagan, Clinton, and W. Bush (and something Obama has not been addressing swiftly enough).
Yale economist Robert Shiller, hardly what one would call a left-winger, has been an oft-ignored voice of reason in the current debate, speaking out against austerity. His point remains: the problem is the drop in aggregate demand from these events that persists still today, and austerity (spending cuts) will only make it worse.
Click below, and I'll go into an analysis of when exactly spending would be a problem, and why spending is not the problem right now, in the sense that Republicans are suggesting (that it's too high, when it's actually too low!). Rather, I will explain why we need higher government spending (stimulus), not cuts in spending (austerity), to fix the underlying imbalances of the economy, and thus why Republicans are dead-wrong when they say spending is the problem.
I've written in the past about the fact that bond vigilantes respond to inflation-risk, not default-risk, in our modern monetary system. I've also written about how national debt can't be paid off, and that it is merely a part of the monetary mechanics of the banking system.
We know that we can handle higher debt loads, and that Japan is a fine example of how extended austerity only leads to stagnation, higher debt, and lower rates in the end. So even though stimulus spending in the US would need to be funded by debt issuance and perhaps even deficit expansion (if there's no new revenues introduced by taxing low-MPC wealthier economic actors), but that isn't problematic, since higher nominal debt doesn't axiomatically lead to inflation or other problems, especially in the absence of any growth.
There's also some fear over rates on debt increasing, in Greek fashion. Nevermind that the Fed controls rates, so this would only happen if we stimulate, which will increase growth, and increase inflation (leading the Fed to increase rates to help stave off inflation), then the rates on our Treasuries will go up. This will only affect new financing. It's not like if you have credit card debt and the rate goes up, that you now have to pay that rate on all your past debt. Treasuries are constructed differently, all the debt that has been issued in the past is not affected by new market price action of yields. When rates jump, it changes the price at which new Treasuries are financed, not the interest we pay on old debt accumulated.
This is a point that progressive economist Dean Baker has highlighted as well. Due to the inverse relationship of bond prices and rates, the US could actually use that kind of opportunity to buy back cheaper debt from the market, reducing nominal debt load.
Additionally, Treasury has been taking advantage of current low rates to lock financing on the longer end, as Nate Silver points out. Not only are we positioned to handle a change in rates, but the Federal Reserve has also published its policy to openly send signals to the market that even if growth picks up, inflation increases, and Treasury rates go up, that policymakers are prepared to deal with this risk.
So if spending isn't a problem, and debt load isn't a problem even if rates do go up (which would only occur with inflation, which won't happen without growth), then when is spending a problem? The short answer is: when inflation becomes a credible risk. When does inflation become a risk? When the supply of money out into the economy is too high, chasing too few real resources.
To visualize this, let's look at a few graphs that show data points that are well-anchored to the two main real resources: labor and capital.
To start, here's generalized inflation:
This is the mainline, continuously compounded. The reason I like to use this is that it really puts things into a historical perspective. It illustrates that in the present day, the inflation figures show we're closer to deflation, rather than run-away inflation. In other words, it shows we have a higher risk of falling into a Japanese-style deflationary trap (and with our much more favorable demographics, this is completely unnecessary) rather than Weimar-style hyperinflation.
It is established then that we are not currently seeing any risk of inflation from the data itself, the Consumer Price Index. This is also seen even in the aggressive alternative private measures of inflation. And so there's nothing for inflation/deficit-hawks to point to to justify their concern. It's purely hypothetical on their part. One may even suggest that there are ulterior motives for such fear-mongering.
With that aside, to judge the risk of potential inflation from higher spending introduced to the economy, let's focus on the resource constraints of labor and capital. We have to look at how much of the capacity is employed for both, because if there's excess capacity, then money thrown into that won't chase too few resources, but will actually employ those which are not in use.
This is the most "conservative" measure or unemployment, which shows marginally-attached or dropped-off-the-rolls unemployed individuals, which the Fed essentially ignores for policy purposes (how convenient).
As we can see, in the context of better economic times recent, this current rate of labor unemployment is more than double what it would be in normal, healthy times. To suggest that there are too few labor resources available is a very hard story to tell, especially in light of the wage stagnation relative to productivity.
If wages aren't budging in real terms, and there's a slew of unemployed laborers in the economy, it's quite clear that there's no supply constraint of the real resource of labor. The supply is actually excessive in this market, so inflation wouldn't come from this real resource squeeze.
Let's move on to capital:
If we switch this graph around, you can interpret it as capital unemployment being over 20%, if it helps to understand it from a different perspective.
Historically, a level closer to 85% of employment is healthier, and around 90% is a nice level of full employment of capital that isn't too "heated" to lead to inflation of goods. However, the cost of capital (represented by interest rates in the economy) is at historic lows: we have a zero interest rate policy, and still that is not enough to stimulate the demand and higher returns to capital, promoting more capital employment.
The area of exception is during the housing bubble in the 2000's, where people made a living from selling houses and associated industries, so the capital unemployment in other industries was easy to ignore, since everyone had a real wealth effect from higher home equity increases thanks to the inflated real estate market.
But in the 2010's there's no bubble to mask this unemployment of capital in the real economy. There's nothing to make up the shortfall, which is why people have had to turn to SNAP and other forms of assistance to support their non-discretionary consumption. Instead, there's plenty of slack in capital markets, so inflation in the economy is more of a bogey man than a credible risk to be found in the current data.
In the aggregate of the US economy then, we can see that labor and capital are not showing any signs of a constraint in supply. It's hard to imagine then that more demand/money chasing this supply would lead to run-away inflation. It stands to reason that an influx of money and demand would actually lead to more production, higher utilization of capital and labor, and more growth in the economy.
If inflation isn't a problem, and debt isn't a problem, then why is spending a problem according to Republicans?
As I've outlined in another previous diary entry, policies of austerity have already been shown empirically to fail miserably in the UK, Eurozone, and Japan. Austerity achieves lower government deficits, which push the private sector into borrowing more (saving less) in order to make up for the trade deficit in the United States. Our dollar's status as reserve currency necessitates a Current Account deficit, which makes austerity extra stupid for our country, as the private sector has to go running to the banksters to borrow. It's no surprise then that the characters behind the "Fix The Debt" and related pro-austerity movements are bankers, financiers, and individuals in industries historically known to have ulterior motives for public policy advocacy.
Thus, if we know austerity is a failed policy, and we know that debt isn't a problem for monetary sovereigns like the US, UK, and Japan, then why are the Teahadists like Rand Paul and Paul Ryan pushing pipe dreams of balanced budgets (a topic I've addressed in a previous diary)?
The answer must be either that they don't understand the economy and actually think that nominal debt levels are hurting the US' growth right now (as evidenced in Paul's appearance on Crowley's show).
Another case in point is Paul Ryan's appearance on Meet The Press, where he confusingly says:
"We’re not preaching austerity. We’re preaching growth and opportunity. What we are saying is if you get our fiscal shift fixed, you preempt austerity."Re-read that in case it doesn't register. Yes, he's saying that to pre-empt austerity you need to...engage in austerity. Over at EconoSpeak, the point is made better than I could:
But Ryan is calling for more government spending cuts so we can avoid austerity? Does this alleged GOP economic guru even know what the word austerity means?If it isn't raw stupidity and misunderstanding, then more nefariously, the GOP must be promoting austerity now as a way to hurt the economy so that Obama and the Democrats can't campaign on a robust economy to win in 2014 and 2016. Austerity would kill growth and jobs, and Republicans could just blame Obama for this and increase their electability in the coming elections.
That would mean that the Republicans are either stupid for not understanding the economy, or they are evil for supporting failed policies as a way to hurt the country and the Democratic Party that is in power today.
But, alas, I will conclude this entry with a few glimmers of hope from both sides of the aisle.
Bobby Jindal, on the Republican side, has spoken out against Austerity, and saying that the Republicans should "stop being the stupid party:"
"We must not become the party of austerity. We must become the party of growth.”Whether this is an Orwellian newspeak strategy, of pushing austerity, but not actually saying they're pushing austerity, is another story.
On the Democratic side, we've got Bill Clinton speaking out against austerity at a retreat for House Democrats in Virginia:
"The debt problem can’t be solved right now by conventional austerity measures, and that’s why Paul Krugman is right when he keeps talking about all these -- everybody that’s tried austerity in a time of no growth has wound up cutting revenues even more than they cut spending because you just get into the downward spiral and drag the country back into recession."And we've got the House Democratic Leader Pelosi echoing this sentiment, sort of at least, yesterday on Meet The Press:
“It is almost a false argument to say that we have a spending problem. We have a budget deficit problem,”She's hinting more at revenues, which I'm all for, at least in the name of reducing inequality. But her comment still smacks of this idea that the national debt accumulation is a problem, which it isn't, per se.
Unfortunately, it doesn't look like the large stimulus plan I'd like to have passed is politically feasible this year (I will post a diary entry later that will outline specifically my reasoning and implementation of a stimulus plan to help reach fuller employment). However, Pelosi's admission on Sunday's Meet The Press helped balance out the rage I felt at Rand Paul's appearance on State of the Union. And for that, I'm grateful. Hopefully public sentiment will continue to sway in this direction.
There are indeed green shoots in the debate over austerity. For a while there it has looked like there was a bi-partisan consensus that the debt was a problem and austerity was necessary. So I'm glad to see that the Very Serious People are coming around on this (at least on the left). It's just a shame that we had to undergo a destructive human experiment on the European people to learn what most Econ 101 students could have told policymakers: cuts in spending in a time of stagnation will only further reduce growth, which will hurt jobs and the aggregate economy.