Post-Keynesian Observations

Understanding the Macroeconomy

Archive for September 2010

Nice Post by Thomas Palley on Econ Policy

leave a comment »

You can find the original here:

Not sure what the first commenter on that page is talking about. This is hardly from the same school of thought that brought us the crisis.

Plan B for Obama on the economy
September 6, 2010 4:54pm
By Thomas I. Palley

TO: President Obama
FROM: Thomas I. Palley
RE: How to avoid stagnation and restore shared prosperity
DATE: Labor Day, 2010

Mr President,

With hopes of a V- or U-shaped recovery fading, there is the increasing prospect of an L-shaped future of long stagnation, or even a W-shaped future in which W stands for something worse.

The reason for this dismal outlook is economic policy is trapped by failed conventional thinking that can only deliver wage stagnation and prolonged mass unemployment.

Your administration’s current economic recovery programme has been marked by four major failings:

1. Inadequate fiscal stimulus.
2. Failure to cauterise the housing market
3. Failure to neutralise the trade deficit
4. Failure to restore the link between wage and productivity growth

If your policy team remedies these four failings our economy will quickly begin robust recovery. However, the longer you wait the greater the challenge, because recession creates new facts in the form of bankruptcies, foreclosures, destroyed credit histories, job losses and factory closures.

Suggested remedies:

1. Let the Bush administration tax cuts expire and use the savings for additional targeted stimulus

The economy needs a further demand boost to establish recovery momentum. The majority of the Bush tax cuts were an income redistribution program favoring the wealthy rather than a stimulus or growth program. That makes extending them bad policy.

The Bush 10 per cent bracket and marriage provisions should be retained, while everything else should be allowed to expire with the savings used to fund new temporary fiscal stimulus.

Half the funds should be directed to state and local governments to help avoid another round of job losses, this time in state and local government. The other half should fund an immediate lump sum non-taxable payment to all individuals earning less than $50,000 ($100,000 for married couples). This means 80 per cent of households will continue benefiting and the total paid to these households will actually increase.

Moreover, the lump-sum design will increase the benefit going to those at the bottom, which will further stimulate demand and also lower income inequality. This temporary stimulus should be repealed once self-sustaining recovery is underway.

2. Cauterise the housing market

The second critical measure is to cauterise the housing market. Throughout the crisis, policy has disproportionately benefited banks and corporations. It has largely failed to help households directly and has instead relied on hopes of trickle-down effects from banks, combined with expensive tax subsidies to attract new home buyers.

The failure to directly help households has been a grievous policy error. Along with banks and corporations, households have needed debt relief but this has not been forthcoming. Banks have resisted meaningful loan modifications, while many households have been unable to refinance mortgages at lower interest rates because of zero or negative home equity. Consequently, the household sector has remained distressed and trapped in a foreclosure tsunami that has traumatised the economy.

Policy must immediately put a floor under existing homeowners. The solution is to use the Federal Housing Administration to refinance Fannie Mae and Freddie Mac mortgages with low or even negative equity and then have Fannie and Freddie repay some of their federal government borrowings. The test criteria should be whether the mortgage is viable once refinanced at low rates.

Additionally, the Federal Reserve must continue with purchases of mortgage-backed securities to ensure that mortgage rates stay low until the housing market has stabilised.

Refinancing such mortgages will yield a huge boost to the distressed corner of the household sector that is currently unable to refinance. It would reduce foreclosures; boost consumer demand by lowering mortgage payments; and it is urgent because adjustable rate mortgages issued late in the bubble are still resetting upward.

The problem has always been inability to service interest costs, and the foreclosure wave could have been avoided if lower interest servicing had been made immediately available to households. Policy did this for the business sector via the TARP and various Federal Reserve rescue facilities but failed to do so for households.

3. Neutralise the trade deficit

The third critical measure is to neutralise the trade deficit. The adverse effects of the trade deficit can be understood through the metaphor of a bathtub. Fiscal and monetary stimulus is being poured into the tub but that demand is leaking out through the plughole of the trade deficit. Moreover, it is not just demand that leaks out, but also jobs and investment due to off-shoring.

The trade deficit and off-shoring are significantly attributable to China’s under-valued exchange rate, which also forces other countries to under-value their exchange rates to stay competitive. This has resulted in an over-valued dollar which makes the US economy internationally uncompetitive.

As China refuses to correct its under-valued exchange rate, it is long past time for the US to take protective action. That can be done via administrative interventions and legislation to make countries with under-valued exchange rates subject to countervailing duties.

There may be trade disruption and retaliation, but the costs of inaction and appeasement are far worse. The problem of under-valued exchange rates was visible a decade ago yet policymakers have failed to take action with devastating consequences.

The choice has always been pay now or pay more later. Inaction means working families have already paid enormously and continued inaction will compound their devastation.

4. Restore the wage – productivity growth link

Finally, policy must address the central problem of the last 30 years: the destruction of the income generating process and severing of the wage – productivity growth link.

Rebuilding that link is critical to recovery and shared prosperity, and it requires rebuilding worker bargaining power. One immediate measure is passage of the Employee Free Choice Act that will enable unions to organise on a level playing field.

A second measure is to index the minimum wage to the median wage. That will create a real wage floor and limit wage inequality because the minimum wage will automatically increase as median wages rise with productivity.

5. Do it all

It is important these measures are enacted as a comprehensive package. Implemented alone they will be far less successful.

Without tackling the trade deficit, fiscal stimulus and the benefits from cauterising the housing market will leak out of the economy. Similarly, increasing union membership and wages will result in an acceleration of job and investment off-shoring.

Fixing the trade deficit without fixing the income generation process and lightening households’ debt burden will leave the economy permanently short of demand.

Escaping the Great Recession requires jumpstarting the economy by increasing demand. Preventing the economy falling back into stagnation requires rebuilding the income and demand generating process. That is why success needs the full policy package.

Thomas Palley is a Schwartz Economic Growth Fellow at the New America Foundation

Written by rommeldak

September 6, 2010 at 2:06 pm

Posted in Uncategorized