demandside

Plus Robert Reich on the logical manifestation of Keynesianism in the current economy. 12.19.08

Today, the Friday Forecast

In honor of the holidays, we couch our unchanged economic prognosis in the rosiest terms possible.  Happy days are here again, or will be after a couple three quarters of hell.

Then commentary from Robert Reich, from a recent blog post.  Reich welcomes the eager re-adoption of traditional Keynesianism by some of the most improbable candidates, but warns that the underlying logic of Keynes leads us toward something bigger and more permanent than many may have in mind.

The Forecast

Demand Side is anxious to demonstrate we operate on both sides of the base line, and use positive as well as negative numbers, so today on the Friday Forecast we come out with the rosiest outlook you’ve heard this week.  We are prepared to stick with our now — compared with the emerging dark consensus — relatively buoyant prognosis for the next two years.

This is decidedly NOT because we believe there is a natural resilience to the economy nor a self-correcting mechanism in the markets.  It is emphatically BECAUSE we expect the Obama economic program to work, and we have much more respect for the impact of public policy — good or bad — than most economists.

Infrastructure investment, big spending in green jobs including building retrofits, assistance to states via Medicare reimbursements, unemployment insurance and food stamp increases, and follow-through on the campaign promises for middle class tax relief.  Each of these has a bigger bang for the buck than any element of last spring’s stimulus.

Even the Obama tax cuts, set to arrive as net long-term cuts, will more likely contribute to spending than did the one-shot temporary rebate checks sent last spring.  Certainly will dwarf the effect of the business tax breaks.  Even here, Obama’s tax breaks for business are focused on employment, and will do better than those in the spring stimulus.

Add to this the not inconsequential boost that will attend Obama’s inauguration and the arrival of honesty and integrity into the White House.  This effect will be doubled by a new competence and purpose in the offices of the administration.

Do not underestimate the stimulus value of low energy prices as well.  If fuel stays low into the second half of next year, there will be a significant bonus stimulus.  All substantial economic recoveries for the past forty years have been attended by lower oil prices.

Housing values will stabilize under Obama because he will insist on programs that are focused on the price of houses and keeping homeowners in their homes.  The write-down of half a trillion dollars in mortgage-related debt is one-half the housing boost.  The other half is renewed activity in the market once the premium for sitting on the sidelines is gone.  That is, right now prospective buyers are waiting until the bottom comes before they buy.  The longer they wait, the further down the bottom.  Once the floor is established by a Home Owners Loan Corporation style program applied universally, these buyers will come into the market.  Housing will not lead the economy out of the recession, but at least it will cease to be a millstone around the its neck.

And speaking of millstones, we also expect the curtain to be closed on the farce in the financial sector.  the Fed’s fever to save the Citigroups of the world and Henry Paulson’s insider blinders will give way to rational thinking and radical surgery on banks and shadow banks.  A structured market will replace the Wild West.  Banks will become like utilities and financing will no longer be a casino operation.

Of course, the federal government does not need banks to finance its spending.  It can borrow at quite reasonable rates directly from the public.  But private investment does need to follow the public push in order for the recovery to be robust.  Here we have a problem.  Demand for financing from distressed borrowers and the trepidation of lenders to lend threatens to smother legitimate, productive investment.  We expect that the focus on green technology and infrastructure will create sectors which will be clearly attractive to investment and lending activity.

There are downsides, too.  In our view the most problematic is that the recession will not be the Great Depression and so will not discourage the free market fundamentalists from their campaign of revisionism.  Just as the collapse has been a wonderful object lesson and has revived Keynesianism and demand side economics, so a clear recovery ought to further enhance their influence.

The opportunity for revisionism and criticism from unrepentant authors of the recent defeat may well have the cover of an inflation that has been baked into the system by the Fed’s easy money and no other policy, or with weakness in the dollar or the drag of the global slowdown.

Make no mistake, the Demand Side short-term outlook is still a grim one, matching the most dire over the next three quarters.  You can see it at demandside one word dot net.  GDP numbers at minus four and a half percent for the next three quarters before recovering sharply.  Net GDP, a figure which incorporates federal borrowing is very grim, but curiously now is not at the bottom of the consensus.  If other economists calculated this metric, they would likely be distributed evenly around our number, thanks to the trillion dollar deficits well in view.  Inflation collapsed with the collapse of the commodities bubble and the simultaneous financial sector crash around the bankruptcy of Lehman Brothers.  Unemployment we see skying to ten percent before it falls back, but again, it falls back sharply.

We remind you that our view has been pessimistic and accurate since we began running them in late 2007.  While it is popular to say everybody has known we were in a recession for a long time, there were not so many saying it back in those days.  We have not seen the worst of the economic downturn, either, and there are plenty of dangers ahead.  On the other hand, the consensus of economists is always wrong, and they are now predicting — I think — a long, slow, Japanese-style stagnation.

If the new administration can maintain its traction, we should expect a much better outcome.

Robert Reich | Dec 16, 2008

Not long ago I was talking to someone who once had been a deficit hawk but the current recession had turned into a full-blooded Keynesian. He wanted a stimulus package in the range of $500 to $700 billion. “Consumers are dead in the water,” he said, fervently, “so government has to step in.” I agreed. But I didn’t tell him his traditional Keynesianism is based on two highly-questionable assumptions in today’s world, and the underlying logic of Keynes leads us toward something bigger and more permanent than he has in mind.

The first assumption is that American consumers will eventually regain the purchasing power needed to keep the economy going full tilt. That seems doubtful. Median incomes dropped during the last recovery, adjusted for inflation, and even at the start weren’t much higher than they were in the 1970s. Middle-class families continued to spend at a healthy clip  … because women went into paid work, everyone started working longer hours, and then, when these tactics gave out, went deeper and deeper into debt.

This indebtedness, in turn, depended on rising home values, …

The second assumption is that, even if Americans had the money to keep spending as before, they could do so forever. Yet only the most myopic adherent of free-market capitalism could believe this to be true. The social and environmental costs would soon overwhelm us. Even if climate change were not an imminent threat to the planet, the rest of the world will not allow American consumers to continue to use up a quarter of the planet’s natural resources and generate an even larger share of its toxic wastes and pollutants.

This would be a problem if most of what we consumed during our big-spending years were bare necessities. But much was just stuff. And surely there are limits to how many furnishings and appliances can be crammed into a home, how many hours can be filled manipulating digital devices, and how much happiness can be wrung out of commercial entertainment.

The current recession is a nightmare for people who have lost their jobs, homes, and savings; and it’s part of a continuing nightmare for the poor. That’s why we have to do all we can to get the economy back on track. But most other Americans are now discovering they can exist surprisingly well buying fewer of the things they never really needed to begin with.

What we most lack, or are in danger of losing, are the things we use in common – clean air, clean water, public parks, good schools, and public transportation, as well as social safety nets to catch those of us who fall. Common goods like these don’t necessarily use up scarce resources; often, they conserve and protect them.

Yet they have been declining for many years. Some have been broken up and sold as more expensive private goods, especially for the well-to do – bottled water, private schools, security guards, and health clubs, for example. Others, like clean air, have fallen prey to deregulation. Others have been whacked by budget axes; the current recession is forcing states and locales to axe even more. Still others, such as universal health care and pre-schools, never fully emerged to begin with.

Where does this logic lead? Given the implausibility of consumers being able to return to the same level of personal spending as before, along with the undesirability of our doing so even if we could, and the growing scarcity of common goods, there would seem only one sensible way to restore and maintain aggregate demand. That would be through government expenditure on the commons. Rather than a temporary stimulus, government would permanently fill the gap left by consumers who cannot and should not be expected to resume their old spending ways. This wouldn’t require permanent deficits as long as, once economic growth returns, revenues from a progressive income tax refill the coffers.

My friend the born-again Keynesian might not like where the logic of Keynesianism leads in today’s world, but the rest of us might take heart.

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