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Can we cut our way to growth?

Dean Baker has a new paper examining "The Myth of Expansionary Fiscal Authority" -- the idea that you can cut your way to growth. The problem, he says, isn't that it's completely impossible, but that the factors that have made it possible in other countries aren't present in the United States. Mike Konczal comments further:

What I’ve noticed about this “growth through austerity” argument is that it requires something else to move. You can cut your way out of a recession as long as you can lower interest rates. Or export your way out of the recession. Or if you are comfortable blowing up your debt-to-GDP ratio. Or if you let unemployment skyrocket further. Or if you are a really small country. The big two are interest rates and exports, and neither are available at the zero bound or in a global recession. And without being able to put this in motion an austerity measure would be very, very ugly.

To be a coldhearted empiricist for a moment, this question will be settled very soon if David Cameron gets his way and Britain begins slashing pensions, jobs and the safety net amid high unemployment, low interest rates and weak global demand.

By Ezra Klein  | October 21, 2010; 10:00 AM ET
Categories:  Economics  
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Comments

Baker is the same man who wrote in the Huffington Post on 9/20/10:

"Had it not been for the bailout, most of the major center banks would have been wiped out. This would have destroyed the fortunes of their shareholders, many of their creditors, and their top executives. This would have been a massive redistribution to the rest of society -- their loss is our gain.

It is important to remember that the economy would be no less productive following the demise of these Wall Street giants."


COME AGAIN? Major center banks, their shareholders, and many of their creditors WOULD HAVE BEEN WIPED OUT, in his own words, yet the economy would have been NO LESS PRODUCTIVE?

I would love to hear Baker explain how the nation's credit system would have operated in the situation he described!

Posted by: 54465446 | October 21, 2010 10:16 AM | Report abuse

>>I would love to hear Baker explain how the nation's credit system would have operated in the situation he described!>>

The govt could have taken the entire equity interest in the failing banks, smaller and saner banks could have taken up the slack, new financial institutions could have taken up the slack, etc.

Posted by: fuse | October 21, 2010 10:22 AM | Report abuse

@54465446 "I would love to hear Baker explain how the nation's credit system would have operated in the situation he described!"

The most likely scenario would have been mid-sized regional banks, such as Union-First Market would have taken over a chunk of the business. Also, not all of the major center banks would have been wiped out without TARP. Chase for example was in much better shape than CitiBank, and you had people like Warren Buffet making deals with Goldman Sachs to provide capital.

I do agree that this would not have been a zero sum redistribution to the rest of society. Some wealth would have been destroyed rather than redistributed.

Regarding David Cameron, it will be interesting to see the effects on business psychology if Britian is perceived as "making the tough choices needed to get it's house in order". One good sign about the British budget cuts is that they are goring everyone's oxen at the same time. Social spending and defense are both being cut.

Posted by: jnc4p | October 21, 2010 10:32 AM | Report abuse

Thanks for the reply from both of you. Aren't you overlooking some things? Some of the institutions that would have been wiped out, Baker's words not mine, are major credit card issuers. Many of these banks are also commercial banks, so the government FDIC is gonna take a huge hit.

Unlike now, where when a bank fails (the list comes out every Friday), other banks take over the operation from the governmneet. With the banks we are talking about, NOBODY left would be big enough to take them over. The government would have to absorb the hit alone. Think THAT might effect the economy a little?

Also, we haven't even begun to talk about what would happen to investor psychology.

This is just another statement from a universtiy professor who runs his own think tank and has spent not one day of his life working in the world where real money is made and lost.

Posted by: 54465446 | October 21, 2010 10:47 AM | Report abuse

"To be a coldhearted empiricist for a moment, this question will be settled very soon if David Cameron gets his way and Britain begins slashing pensions, jobs and the safety net amid high unemployment, low interest rates and weak global demand."

Exactly Ezra! I had been waiting for your this precise comment.

What we need is Paul Krugman to respond. Sometime back there was one big article 'who is right - Paul Krugman or James Paulson'; later being the guy who made the money on Housing Down turn (made money? Dude he minted Billions....) and who was betting that Great Recession will be a normal recession and USA will come back. Krugman has been pointing the structural issues how this time it is different than the standard post-WWII recession so far. I believe it was JJ Cramer who was the author.

Anyways James Paulson is coming cropper so far and Krugman is right.

Then Taylor Cowen and other Conservative gang tried to attack Krugman thesis by Merkel's Germany. For a while it seemed like Krugman was on the rope. But two things happened:
- Germany is in unique position where it anchors EU, does not mind carrying the burden of that as long as Euro is in free fall to fuel it's export. That music is coming to an end and predictably Germany is already uneasy here.
- Next, despite that Krugman published a graph showing that USA growth rate was comparable or rather better than Germany.

And now comes the UK Test for Krugman thesis. Ireland and other smaller economies do not matter. What matters for USA is the comparison with Japan, Germany and UK due to structural similarity of these economies as well as respectable sizes in Trillions.

For Japan, Krugman has been arguing that USA will come to envy Japan when our deflation starts the vicious churn. I am not convinced there....

My gut feeling is Camron UK will 'pull off' this trick. Why?

Basically I agree with Krugman's Keynesian Economic measures of Government induced demand even if it is borrowed money. The question is how do we spend that borrowed money - what I find Krugman never talking is about borrowed money spend on bloated State level bureaucracy. He puts all sorts of intelligent arguments saying it is perfectly fine to keep spending money on bloated State employees where their salaries, pensions and other benefits are out of whack.

That sure happened for Stimulus money. As you said some time back, Obama Admin never put strong conditions for reforms on State level when the money was flooding from DC to State Capitals.

Next, there is no such things as shovel ready projects... (I know you disagree, but I think President got that right.)

Finally, the Tax cuts were too diffused to make difference as well whereas Medicaid money continue to go to a health system which is one of worst in the world when it comes to cost; no reforms there.

In short - quality of spending on borrowed money matters and I feel Krugman does not want to consider this.

Cameron UK - I think they may get it right.

Posted by: umesh409 | October 21, 2010 10:57 AM | Report abuse

"The most likely scenario would have been mid-sized regional banks, such as Union-First Market would have taken over a chunk of the business."

With what capital? Even with capital, the smaller banks didn't have the scale to suddenly fill in for the money center banks. Nevermind that the small banks aren't going to even maintain loan issuance with the failure of the big guys, let alone double or triple volume to make up for them.

Outside of that, many of the smaller banks are the ones that aren't paying back TARP today because they were (and are) overexposed to commercial real estate.

"Also, not all of the major center banks would have been wiped out without TARP."

Possibly but not certainly true. The failure of the larger banks would have reduced credit availability and caused a larger initial downturn, possibily forcing a few other banks under. Large banks might also have had difficulty with finding funds in the wake of other large banks imploding.

Bank of America and Citi had over a trillion in deposits between the two of them. Not only would that have been a large check the FDIC would have had to write, but tens or even hundreds of billions of that amount were uninsured.

In addition, these banks provide emergency liquidity in the form of revolving credit lines - not only would the downturn have been more severe, but businesses which had revolving lines with the failed banks would have lost access to credit.

In terms of markets, consider that the decline in all asset classes would have been more severe - housing, stocks, bonds. Lower 401(k)s, destroyed pension funds, etc.

And my goodness, would we have deflation. Not "OMG, inflation is only 1% YoY" type problems, but real, deep and rapid annual price deflation.

While the downturn would have been more severe, once it was over the rebound would have been very rapid (think 1933-1937). You'd have greater inventory lift, greater pent up demand, no bad credit overhang. Also, the moral hazard issue would have been addressed, and in all probability state and local governments would have had to break promises to the public sector unions.

Once prosperity returned, it would likely be a stronger prosperity.

So this doesn't mean that you have to support the bailouts. It just means its foolish to think that there would only be distributional consequences to widespread failure.

"It is important to remember that the economy would be no less productive following the demise of these Wall Street giants"

The economy was no less productive in 1933 than in 1929, it is just that much of that capacity wasn't employed.

Posted by: justin84 | October 21, 2010 11:54 AM | Report abuse

justin84:

Thanks for backing me up on this. Baker is a bomb thrower, because that's what he gets him in print. No economist that has ever worked with their own or shareholder money would have ever said what Baker did!

Posted by: 54465446 | October 21, 2010 12:43 PM | Report abuse

54465446: "COME AGAIN? Major center banks, their shareholders, and many of their creditors WOULD HAVE BEEN WIPED OUT, in his own words, yet the economy would have been NO LESS PRODUCTIVE?"

Technically, yes of course. Destruction of Wall Street wouldn't change one gear or knob on any machine in the economy. But, (as I seem to remember that Baker has written elsewhere), there is no doubt that Wall Street has us by the short hairs, as long as there is nothing like Glass Steagall to separate banking and credit from gambling. Indeed, many of us argued in these very comments that the bailout was necessary, against rightwingers and leftwingers alike. Why you great business geniuses don't get to the root, is the most mystifying thing of all.

Posted by: Lee_A_Arnold | October 21, 2010 3:49 PM | Report abuse

Anytime 54465446.

It's hard to believe anyone would take such comments seriously.

I see reasons to oppose ad-hoc bailouts, but that nothing would have been different (and temporarily worse) without them isn't one of those reasons.

Posted by: justin84 | October 21, 2010 3:53 PM | Report abuse

Lee arnold wrote:

"Why you great business geniuses don't get to the root, is the most mystifying thing of all."

LOL don't blame me, help educate Ezra. It's his column!

Posted by: 54465446 | October 21, 2010 4:32 PM | Report abuse

Then you think we should have Glass Steagall back, or something like it? Because so far you have refuted neither Dean Baker nor Ezra Klein.

Posted by: Lee_A_Arnold | October 21, 2010 5:15 PM | Report abuse

It was foolish to get rid of it, but you can never build something back once it's gone. The financial world is too much a changed place. The President gave too much ground when he went after health care rather than financial regulation first.

LOL, No one who has money, had money, or who ever wants to have money would listen to Baker. His statements are just plain foolish bomb throwing.

Armchair quarterbacks who now say we shouldn't have done TARP weren't around at that time. They were off writing columns in universities where they can propose or criticize anything and nobody has a dime at stake.

It's always like that between the people who do things, and the people who criticize people who do things.

"I think that, as life is action and passion, it is required of a man that he should share the passion and action of his time at peril of being judged not to have lived."

Oliver Wendell Homes

Posted by: 54465446 | October 21, 2010 10:04 PM | Report abuse

"Then you think we should have Glass Steagall back, or something like it?"

What good would that do?

http://www.marginalrevolution.com/marginalrevolution/2008/09/glass-steagall.html

"Because so far you have refuted neither Dean Baker nor Ezra Klein."

Baker has been refuted on the 'no TARP, no problem' issue. While not without some benefits, letting the financial sector bear the full force of the downturn would have meant a deeper downturn, no question.

As for the "cutting our way to growth", in the short term I'm in agreement. A large cut in expenditures frees up resources to be used elsewhere, though those resources are not instantly redeployed. In the medium and long term, however, resources are used more effectively by the private sector, boosting growth.

Posted by: justin84 | October 21, 2010 11:42 PM | Report abuse

You didn't answer the question, and now you are resorting almost entirely to various species of gibberish: You certainly can build something back once it's gone... The fact that the world has changed only means that you do it differently... Financial regulation was passed after healthcare... Dean Baker has been writing continuously and accurately since very long before the TARP... Let's get a quote from Oliver Wendell Holmes or someone else which counterpoises your vacuity... Etc.

But the real clue that you are probably our local rep from the blog comment management department of American Crossroads is that you failed to present Baker's main argument from the place you lifted his quote: that the Fed was almost certainly prepared to sustain the system of payments and credits if the big giants collapsed. In fact the Fed has had occasion to plan for it in the past. That's a legitimate argument, with a more moral outcome. I think it would have been a bigger logistical mess, and politically impossible, but that's different than what you wrote, which is that Baker gave no thought to it.

And surely the Baker quote you lifted is accurate: the economy would be no less productive because real productivity is disconnected from the performance of Wall Street. Productivity is for that matter actually disconnected from the system of credit -- credit keeps the wheels turning and allows new investment for innovation, sure, but it is not the source of innovation.

So far, the score is: Dean Baker 3, 54465446, zero.

Posted by: Lee_A_Arnold | October 21, 2010 11:45 PM | Report abuse

Lee wrote:

"And surely the Baker quote you lifted is accurate: the economy would be no less productive because real productivity is disconnected from the performance of Wall Street. Productivity is for that matter actually disconnected from the system of credit -- credit keeps the wheels turning and allows new investment for innovation, sure, but it is not the source of innovation."

So we have eliminated credit as being connected to productivity. We have eliminated Wall Street too. I'm afraid we just fundamentally disagree.

I know of only three real ways to increase productivity, or maintain it in a downturn:

1) borrow to expand your business to increase market share

2) borrow to obtain new equipment to work more efficiently

3) fire people, and do the same or increased business with fewer people.

Since you are elimnating the first two, I guess we are stuck with firing even more people?


A blogger is just a university professor before he grows the beard and moves into an old brick building. Too late for me, I actually risk my own money, not the taxpayers.

If Baker has been accurate all along, where's his money, where's his company? I'm sure that you know plenty of economics professors have gone into business and some have done extraordinarily well. They are the ones who I have the greatest respect for.

Why should I listen to Baker over say John Paulson, who risked his OWN money on his reading of the economy and made a billion?

When I was ready to throw in the towel, I didn't listen to Baker or any other economist. I saw that Buffet made a deal with Goldman at maybe the worst time. I decided that if Buffet was still in, so was I because who knows the economy better than Warren Buffet, Dean Baker?

"you failed to present Baker's main argument from the place you lifted his quote: that the Fed was almost certainly prepared to sustain the system of payments and credits if the big giants collapsed."

I failed to present it because the article was full of bad ideas, and I couldn't tackle them all. This is akin to saying that not only can the firemen who respond to your house fire put the fire out, but they can actually rebuild it while they are doing so!

Neither of us can prove it analytically thank God, but I believe just dealing with the fallout of the collapse or near collapse of the FDIC, and the ruin of many of the major Wall Street institutions would be enough without the Fed having to try to run the ecnonomy too.

Remember the Fed board of governors is now almost completely composed of university professors and government advisors. It's original composition was entirely bankers. You may have a better opinion of their ability to run the economy than I do. (Tim Geithner anyone?)

I have enjoyed this, perhaps more than you. thanks for the reply.

Posted by: 54465446 | October 22, 2010 11:13 AM | Report abuse

A lot more misdirection and blabber. I wrote,

"credit keeps the wheels turning and allows new investment for innovation"

-- and you wrote,

"I know of only three real ways to increase productivity, or maintain it in a downturn:
1) borrow to expand your business to increase market share
2) borrow to obtain new equipment to work more efficiently...
Since you are elimnating the first two, .."

-- But I specifically just INCLUDED the first two.

As for the rest, this whole folksy avuncular tut-tutting about the better judgments of businesspeople is, in this economic climate, ludicrous. It might be wiser for you to jettison this nonsense, and stick to judgments about people on an individual basis, and with regard to what each one actually says.

Everybody already knows that a well-functioning financial system is essential to a modern economy. You can bet that Baker knows it, and he probably knows a lot more than most people about it. He was also one of the very few economists who had a clue about the mortgage bubble from the earliest days. Perhaps John Paulson read him many years ago?

Yet why people should have to bet their money on things to prove their worth is one of the great mysteries of the psychology of the reptilian brain cortex. Perhaps you are a great fan of Keynes, who made a mint?

Posted by: Lee_A_Arnold | October 22, 2010 1:46 PM | Report abuse

Lee:

Thanks for the response. You have SELECTIVELY quoted from your own post however:

"Productivity is for that matter actually disconnected from the system of credit --"

is the beginning which you conveniently left out and why I wrote my statements.


I am luke warm on Keynes. I am actually more familiar with his work at the Paris Peace Conference of 1919, where he was spot on, than his overall writings.

We have philosophical disagreement on economists. There is a reason they don't make sportwriters and broadcasters into coaches and general managers because the difference between talking and doing is a huge gap.

For instance in Baker's case, he writes about letting the banks fail as an academic exercise. To actually be in the room when the decision is made. To know that your words change in fact and not in theory. To have the real American economy in your hands at a single moment when YOU have to make that decision is another world from academia. THAT"S why I place so much value on people who have actually had their own money at risk.

Perhaps you were watching a financial network in those days at the end of the Bush administration wondering what would happen to Lehmann and what the Fed would do. For me, it was about my money, my lifestyle, my children's future. I wasn't working for a university that wouldn't close down or as a government advisor. If you haven't been there you don't know, as is true in most walks of life, probably whatever business you are in too.

Across all sports there is a saying that at the end of the game some people want the ball in their hands and some don't. Whatever you think of Hank Paulson and the Bush administration, aren't you at least a little glad that when the decision had to be made right now, it was he and not Christina Romer or Dean Baker in that seat? (yes I give credit to the academician Bernanke too, they complemented each other very well)

As always, I enjoy the give and take. I would hate to be on a thread with all my own kind!

Posted by: 54465446 | October 22, 2010 2:31 PM | Report abuse

Productivity is defined as output per labor hour. The system of credit is disconnected from this definition. It also must be disconnected in reality, or else there would have been much more productivity over the last 40 years.

Now don't be dull, you need money, credit, investment, but it looks like that is not even a primary cause of productivity. Far less does it justify the current organization of Wall Street as the only means to productivity. Which is what Baker said in other words.

"For instance in Baker's case, he writes about letting the banks fail as an academic exercise. " -- Yesssss indeed, all along you have been taking exception to an academic remark.

"The distance between talking and doing is a huge gap," as you wrote. The distance between talking and thinking must be even larger. Because the characterization of someone by his trade can't possibly work as a rule. There are good and bad economists, and there are good and really really really bad businessmen. You are engaging in a variant of "argument by authority," -- a fallacious proof. for example, doesn't the generalization by type leave you guilty with the worst of your own type?


"Whatever you think of Hank Paulson and the Bush administration, aren't you at least a little glad that when the decision had to be made right now, it was he and not Christina Romer or Dean Baker in that seat?"

Oh well here we go... Now we are to be gladdened by the guidance of one of the great businessmen, George W. Bush? But really -- "aren't you at least a little weary" of platitudes? Did you used to write copy for action figure commercials?

"All your own kind?"! For this crisis to occur, didn't the functioning brains among your "kind" fall down on the job, to begin with? Isn't the practical question why a capable resolution authority wasn't ready, and what to do about it now?

Posted by: Lee_A_Arnold | October 22, 2010 7:28 PM | Report abuse

Lee:

A perfect example of what I'm talking about occured today in the Obama administration. Denis McDonough was named Assistant National Security Advisor, replacing his boss Thomas Donilon who moved up to National Security Advisor replacing the departed General James Jones.

How does that matter you ask? Well as it turns out neither Donilon or McDonough has ever been involved in the military, law enforcement, prosecution, intelligence, the foreign service, or even emergency management.

So what do they bring to the table?

Well, Donilon is a lawyer who used to work for Fannie Mae and has a relatioship with Joe Biden.

McDonough went to the Hill after college and never left holding a series of aide and think tanks jobs until he hitched a ride with Obama.

Here is the description of Donilon from Woodward's book. This is a supposed summarization of a conversation that Jones had with him:


"First, he had never gone to Afghanistan or Iraq, or really left the office for a serious field trip. As a result, he said, you have no direct understanding of these places. "You have no credibility with the military." You should go overseas. The White House, Situation Room, interagency byplay, as important as they are, are not everything.

Second, Jones continued, you frequently pop off with absolute declarations about places you've never been, leaders you've never met, or colleagues you work with. Gates had mentioned this to Jones, saying that Donilon's sound-offs and strong spur-of-the-moment opinions, especially about one general, had offended him so much at an Oval Office meeting that he nearly walked out."


Call me crazy but it sounds analogous to Baker's opinions about business and the economy.

Posted by: 54465446 | October 22, 2010 7:48 PM | Report abuse

Oh for God's sake. By your measure, half the things in the universe are analogous to the other half of things. I have to defend every clown in government so as not to notice that you are fumbling the ball? You should just come out and SAY that you prefer that the government acts to bailout the system of ownership that preserves your own ownership of things. This isn't a big mystery and it's far more honest and comprehensible than your babbling that someway, somehow, men-of-action are in-the-know. Stop hiding behind "productivity" and stop hiding from the failure to have a resolution authority to get the scumbags out of banking. It should have been obvious that's what Baker is talking about too.

Posted by: Lee_A_Arnold | October 22, 2010 9:38 PM | Report abuse

Lee:

This thread is done, but it has been a pleasure. We will no doubt meet again on another thread.

BTW, I'm actually a Democrat, believe it or not.

Posted by: 54465446 | October 22, 2010 10:52 PM | Report abuse

Well then that explains it. You shouldn't run away from the argument so soon, because I want to know how it can be that half of you clowns in the Democratic Party believe in Reaganomics, and always acquiesce to Republican tax cuts, and then take the blame for the resulting deficits. Because every step in that is unbelievably stupid.

Posted by: Lee_A_Arnold | October 23, 2010 1:58 AM | Report abuse

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