Friday, September 24, 2010

Ten Second Sumner

I normally try to edit more than this (5 second rather than 10) but Sumner has been writing some particularly good stuff of late. Here is the short version:

Income: A meaningless, misleading, and pernicious concept

I will try to convince my progressive readers that they should favor complete abolition of all personal and corporate income taxes…  Suppose 2 brothers both make $100,000 a year.  … Now assume it’s possible to invest income at a real rate of interest that allow one to quintuple one’s wealth between age 25 and 65.  … One eats $100,000 worth of blueberries today; the other eats $60,000 today and saves $40,000.  After 40 years the thrifty brother gets to eat $200,000 worth of blueberries.  … Here’s my question:  In this society is there any economic inequality?
I don’t see how anyone could say there is.  Both have exactly the same wage income at age 25.   Yes, they do different things with it, but that’s their choice.  At age 65 one has zero income outside social security, and the other has $160,000 in capital gains, which is generally considered “income.”  But nonetheless there is complete equality for two reasons:
1.  Both are free to choose whether to save or not, so we have no evidence that one brother had more utility than the other.
2.  In present value terms their total lifetime consumption of blueberries is identical.
The mistake is assuming that blueberries in 40 year are the same thing as blueberries today.  Future blueberries only cost 1/5th as much, as they are much less valued than current blueberries.  They are different goods just as much as watermelon and blueberries are different goods.  That $160,000 gain is not “income” in the way most people think of the term, i.e. as some sort of goodie available for spending.  Rather it reflects deferred consumption.  The $200,000 received at 65 is exactly equal in present value to the $40,000 saved today.  Indeed it is the very same wealth, simply measured at a different point in time.  It is nonsensical to say the thrifty brother has income of $100,000 today plus another $160,000 at age 65, you’d be counting the same income twice.  
[He then shows that a labor tax and a VAT would have the same impact on both brothers, but an income tax would tax thrift more.]
Unlike most libertarians, I think a progressive payroll tax is desirable for simple utilitarian reasons.  I don’t buy the “I worked hard for it, it’s my money” argument, for two reasons:
1.  Most of your income comes from luck.  If you’d been born in a poor peasant household in Asia or Africa, your income would be low no matter how hard you worked.  You hit the jackpot just being born in a developed country.
2.  Our wealth comes from living in a highly functional society, thus part of your wealth is due to the fact that your neighbors don’t go around raping and pillaging as in the old days, but rather peaceably go to polling stations to vote.  Am I saying; “It Takes a Village?”  Sort of, more precisely “it takes a civic-minded culture.” …
I think people have a huge mental block about these ideas, because they grossly misunderstand the actual incidence of taxes.  For instance, most people think consumption is much more equal than income, and hence that consumption taxes are regressive.  Actually, consumption taxes are proportional to consumption, which is the only meaningful benchmark.  Income is meaningless gobbledygook.  And most people think wealth is much less equal than income.  But how can both of these perceptions be correct, when wealth is nothing more than the present value of all future consumption for you and your heirs!  Actually, inequality of wealth and consumption are exactly equal, when properly measured in present value terms.  … And the reason is that our minds are being twisted and distorted by a meaningless concept—income.  People find it hard to shake the notion that income is actually measuring something meaningful. 

Tyler Cowen and Tinkerbell

I do get a lot of conservative commenters complaining that I am trying to get Americans to save less and spend more.  Not true.  Keynesians are trying to get Americans to save less and spend more.  I am trying to get Americans to consume more and save more.  But most of all, I want them to reduce their demand for base money.  I want them to hoard less cash, not save less income.  That would increase NGDP, allowing both more saving and more consumption.
I’d be thrilled if people and banks started taking all that base money out from under cushions, or out from excess reserves, and started buying assets like bonds, stocks, commercial REITs, etc.  Of course this “spending” isn’t consumption, it’s saving.  But it would boost asset prices and increase investment in the economy.  And that would be great.  So I do have a slight fear that talking about the need for Americans to save less will send out the wrong message, especially to conservatives who have a well-justified instinctive feeling that one of America’s problems is that we don’t save enough.  There’s never a bad time to save more, as long as you don’t increase your real demand for base money.
Tyler’s at his best when considering the issue of credibility:
In a self-fulfilling prophecy, the Fed could stimulate spending and the economy, and at no cost to the Treasury. Of course, if no one believes the Fed’s commitment to price inflation, spending and employment will not go up. The plan will fail, and people will view their skepticism as vindicated.
In other words, one of our economic problems can be solved, but only if we are willing to believe it can.
In a way this is true, but it tends to create an excessive sense of pessimism.  The reader is left wondering how likely it is that American would expect higher inflation, merely because of an announcement by the Fed.  But there’s more to it than that… It is extremely unlikely that an aggressive move by the Fed would be met by indifference on Wall Street.  And it is Wall Street’s reaction that matters most, not the views of a housewife in Dayton, Ohio.  So the Tinkerbell-like comment “only if we are willing to believe it can” might be misunderstood by the average reader….
Suppose the Fed were to say [instead of targeting higher inflation, targeting higher incomes:]
 ”For several decades the total income of Americans rose by just over 5% a year, and we had a healthy economy.  In the last two years there has been almost no growth in the total income of Americans.  We are going to adopt a more expansionary monetary policy with the goal of faster growth in aggregate incomes.  If Americans have more income, then they will be better able to service their debts, and the banking system will be in better shape.  Because the economy current has a lot of slack, we believe that we can achieve 7% annual income growth over two years, and 5% thereafter, without pushing inflation above the 2% to 3% norm of recent decades.”…
Here’s my favorite part of Tyler’s column:
the Fed hasn’t been acting with much conviction … because if the Fed announces a commitment to a higher inflation target but fails to establish its credibility, it will have shown impotence. It would be a long time before the Fed was trusted again … All of a sudden, the Fed would end up “owning” the recession.
I love that last sentence.  I think the Fed is afraid of “owning” the business cycle, and always has been.  … In the minutes of the November 1937 Fed meeting, one member all but admitted that the Fed was reluctant to reverse the increase reserve requirements, because that would be tantamount to admitting the Fed was guilty of triggering the recession.  So they put their own reputation ahead of the public interest.  (Yes, I know that powerful people often have trouble distinguishing between the two.)
I already believe the Fed “owns” this recession, but most people don’t.  Suppose the Fed did everything I wanted, and it worked exactly as I thought it would work.  Wouldn’t that cause more people to go back and re-examine what the Fed did in 2008?  Perhaps a few people might start muttering ”perhaps Hetzel, Congdon, Sumner, Beckworth, Thompson, etc, were correct about 2008.” …
Tyler’s interpretation might also be correct… :
1.  The mere fact that the Fed announced an intention to boost inflation, would suggest that the Fed thought they always had the power to do so, but were reluctant to pull out the “nuclear option” because they didn’t think the recession was that bad.  Maybe (people would mutter) the Federal Reserve elite don’t personally know anyone who is unemployed.
2.  And suppose the policy fails to boost inflation, would that let the Fed off the hook?  I doubt it.  Does anyone believe a determined central bank couldn’t produce Zimbabwe-style inflation, if it bought up the entire world stock of wealth?  … They’d be mocked “What, are you guys so incompetent that you don’t even know how to debase your own currency.   Even the Zimbabweans can to that!  No, failure would not be an option.
As much as I hate to admit it, I fear Tyler is right.  The more aggressive the Fed’s move, the more “ownership” they’ll take for the recession.  And that’s true whether they succeed or not. 

No soul-searching on the left?

I hope I’m not being impolite by bringing up a few inconvenient truths.  As far as I can recall there were virtually no articles in the leading elite newspapers (WaPo, NYT, LA Times, NYR of B, etc) talking about the urgent need for more monetary stimulus [while now they are talking about the “massively consequential decision” of picking 3 new Fed governors.] … So here’s my question; if there’s nothing to be done when rates are near zero, then why is the Fed now facing a “massively consequential decision”?  Indeed rates were in the 1.5% to 2% range throughout September and October 2008, so not only was the need much greater at that time, but the Fed’s ability to deliver monetary stimulus was also presumably much greater.  …
Obama didn’t even offer up any names until a few months ago. Perhaps Obama’s one of those arrogant liberals who believes all right-wingers are morons.  Perhaps he never read any Milton Friedman, and never learned that monetary policy is still highly effective at the zero bound.  Maybe he just read Keynes.  Maybe he just relies on reporters who didn’t know about the “massive” importance of monetary policy in early 2009.  Maybe he relies on liberal economic advisers who didn’t understand the massive importance of monetary policy in early 2009.  So he let Fed seats sit empty, instead of immediately filling them with pro-stimulus academics when his high popularity would have allowed them to sail through the Senate….
Don’t get me wrong, I’m thrilled to see all the sudden liberal support for unconventional monetary stimulus, and I’m angry about Republican senators using delaying tactics.  But I’m also frustrated by the lack of soul-searching on this issue.  It’s clear to me that if all these liberal bloggers and liberal newspapers … have suddenly woken up to the fact that monetary policy can be highly effective at the zero bound, then the macro model they had in their heads in late 2008 and early 2009 was in some sense flawed.  You’d expect some sort of re-examination of how we got here.

Britain discovers the near-zero fiscal multiplier

It’s now generally accepted [in graduate level economics] that the fiscal stimulus multiplier is roughly zero in countries where the central bank targets inflation.  … We haven’t yet figured that out, but the new British government seems to understand. … And why do they think the fiscal austerity will have such a small impact?...
The government thinks its harsh fiscal policies will permit more monetary balm, whether through resuming the policy of quantitative easing or keeping interest rates lower for longer. Judging by this week’s report, the central bank is in no mood to tighten policy and takes the view that the rise in inflation will eventually be doused by spare capacity.

Case closed: Milton Friedman would have favored monetary stimulus

But I have found an even more recent Friedman article that sharply undercuts the only plausible argument that Friedman would have been with the inflation hawks.  In 2003 he wrote a very interesting article on recent trends on monetary policy, and basically made peace with the new Keynesian inflation targeting approach:
To keep prices stable, the Fed must see to it that the quantity of money changes in such a way as to offset movements in velocity and output. Velocity is ordinarily very stable, fluctuating only mildly and rather randomly around a mild long-term trend from year to year. So long as that is the case, changes in prices (inflation or deflation) are dominated by what happens to the quantity of money per unit of output.
… Yet since the mid ’80s, it has managed to control the money supply in such a way as to offset changes not only in output but also in velocity. … The improvement in performance is all the more remarkable because velocity behaved atypically, rising sharply from 1990 to 1997 and then declining sharply — a veritable bubble in velocity. … Velocity peaked in 1997 at nearly 20% above its trend value and then fell sharply, returning to its trend value in the second quarter of 2003.
The relatively low and stable inflation for this period … means that the Fed successfully offset both the decline in the demand for money (the rise in V) before 1973 and the subsequent increase in the demand for money. During the rise in velocity from 1988 to 1997, the Fed kept monetary growth down to 3.2% a year; during the subsequent decline in velocity, it boosted monetary growth to 7.5% a year.
Some economists have expressed concern that recent high rates of monetary growth have created a monetary overhang that threatens future inflation. The chart indicates that is not the case. Velocity is precisely back to trend. There is as yet no overhang to be concerned about.
Note that Milton Friedman is criticizing “some economists” who have “expressed concerns that the high rate of money growth . . . threatens future inflation.”  … And Friedman is telling his fellow conservatives (from the grave) that they are wrong, that this “is not the case.”
Friedman would have understood that the financial crisis was a special case that led to a rush for liquidity and safety, and a temporary fall in M2 velocity.  He would have seen the low interest rates and low TIPS spreads as indicators of tight money.  He would have favored temporarily allowing higher M2 growth to offset the low velocity, until the economy was back to normal.  Somehow modern conservatives seem to merely recall the bumper sticker message “stable money growth” but overlook the nuanced and highly sophisticated monetary analysis that made Milton Friedman an intellectual giant.

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