The Check Tax

From the NBER Reporter Fall 1995 page 31, summarizing William D, Lastrapes and George Selgin, University of Georgia, “The Check Tax and The Great Contraction”, a paper delivered at the Workshop on Macroeconomic History, Oct 13 In Cambridge, Mass.

“Although its role has been overlooked by monetary historians, a two cent tax on bank checks effective from Jun 1932 through December 1935 appears to have been an important contributory factor to the periods severe monetary contraction. According to estimates by Lastrapes and Selgin, the tax accounted for between 11 percent and 17 percent of the total increase in the ratio of currency to demand deposits and for between 11 percent and 19 percent of the total decline in M1 between October 1930 and March 1933. The contractionary consequences of the check tax had been anticipated by many legislators, but they were unable to prevent the measure from being included in the Revenue Act fl 1931.”

The resulting paper can be found at papers.ssrn.com/sol3/papers.cfm?abstract_id=33320

I have read a fair amount about monetary history and the Great Depression and I do not recall hearing about the check tax.

(This piece is the result of reading and discarding old publications of the NBER.)

Does fiscal policy work?

The military buildup or World War II is often cited as a successful prediction of Keynesian economics. Usually forgotten is what happened at the end of the war. David Henderson summarizes:

In a 2010 study for the Mercatus Center at George Mason University, I examined the four years from 1944, the peak of World War II spending, to 1948. Over those years, the U.S. government cut spending from a high of 44 percent of gross national product (GNP) in 1944 to only 8.9 percent in 1948, a drop of over 35 percentage points of GNP. The result was an astonishing boom. The unemployment rate, which was artificially low at the end of the war because many millions of workers had been drafted into the U.S. armed services, did increase. But between 1945 and 1948, it reached its peak at only 3.9 percent in 1946. From September 1945 to December 1948, the average unemployment rate was 3.5 percent.

There was a sharp decline in real GNP at the end of the war, but Henderson says that is an artifact of the ending of price controls. The price controls hid what the actual prices were, so the jump in the price index was not capturing a real rise in prices. But that illusion of a jump resulted in a decline in reported real GNP. (An implication of this is that real GNP was overstated during the war because the price index was not capturing the rise in prices.)

How does Henderson explain the boom?

But why did this postwar boom occur? The answer, in a nutshell, is that the U.S. economy went from being centrally planned, with price controls and government allocation in large sectors of the economy, to being much more free market. During the New Deal, Franklin Roosevelt had many advisors who were hostile to free markets. But during the war, Roosevelt, although he centrally planned the economy for the duration, kicked out most of his anti-market advisors, people like Ben Cohen, William O. Douglas, trust-buster Thurman Arnold, price controller Leon Henderson, and Felix Frankfurter. In 1945 and 1946, Harry Truman got rid of the remaining New Dealers, including two of the most prominent ones: former Vice President Henry Wallace and Harold Ickes.

Nobel Prize

The Nobel Prize in Economics was awarded to Thomas Sargent and Christopher Sims. Here is Sargent last year commenting on the 2009 stimulus package"

In early 2009, President Obama’s economic advisers seem to have understated the substantial professional uncertainty and disagreement about the wisdom of implementing a large fiscal stimulus. In early 2009, I recall President Obama as having said that while there was ample disagreement among economists about the appropriate monetary policy and regulatory responses to the financial crisis, there was widespread agreement in favor of a big fiscal stimulus among the vast majority of informed economists. His advisers surely knew that was not an accurate description of the full range of professional opinion. President Obama should have been told that there are respectable reasons for doubting that fiscal stimulus packages promote prosperity, and that there are serious economic researchers who remain unconvinced.

update: Another quote, from a graduation address:

“Everyone responds to incentives, including people you want to help. That is why social safety nets don’t always end up working as intended.”

Jobless recoveries

From the Bureau of labor Statistics:

(Click on the graph to see the whole thing.)

The recovery after the 2001 recession has been called the "Jobless Recovery," but job growth then was no worse than what we have seen after the 2007-9 recession.

Procyclical policy?

The regulatory authorities lowered capital requirements during the boom and now want to raise them during the bust. A reaction:

Bove points out that the proposal, which he dubs absurd, would “effectively take U.S. banks out of the financial system for an extended period. It would have a similar impact on the economy as the Fed’s two reserve ratio increases in 1937 which plunged the United States back into depression.”

Why no recovery yet?

Writing in the Wall Street Journal, Gary Becker, Steven Davis, and Kevin Murphy ponder why the recovery has been so slow. They argue, though not using the term, that the Obama Administration has pursued bad supply-side policies.

In terms of discouraging a rapid recovery, other government proposals created greater uncertainty and risk for businesses and investors. These include plans to increase greatly marginal tax rates for higher incomes. In addition, discussions at the Copenhagen conference and by the president to impose high taxes on carbon dioxide emissions must surely discourage investments in refineries, power plants, factories and other businesses that are big emitters of greenhouse gases.
Congressional "reforms" of the American health delivery system have gone through dozens of versions. The separate bills passed by the House and Senate worry small businesses, in particular. They fear their labor costs will increase because of mandates to spend much more on health insurance for their employees. The resulting reluctance of small businesses to invest, expand and hire harms households as well, because it slows the creation of new jobs and the growth of labor incomes.
....
By failing to adopt a measured approach to economic policy, Congress and the president may be slowing the economic recovery, and thereby prolonging the distress from the recession.

economic simulator

The Fed has another economic simulation for students:

http://econsimulator.com/

I have not tried it yet.

JOLTS

A column by Jerry Bowyer at NRO introduced me to a new set of labor statistics, the JOLTS or Jobs Openings and Labor Turnover Survey. The hire rate has been declining for several years. In July of 2008 it slipped below 3.5, and the latest report, for June 2009, it has slipped below 2009. Business is reluctant to hire. Bowyer argues that it is because business is scared of the tax burden of hiring--any fires increase unemployment insurance they must pay.

Obama has made them scared. Everywhere I go I hear the same story. Business owners know the little details that academics and pundits don’t, and they know what not to do. They know, for example, that payroll taxes are not only scheduled to rise, but already have risen. And they know all too well that government-mandated unemployment compensation is funded by employers through an unemployment-compensation payroll tax. As a result, they know not to hire.

A problem with that explanation is that it does not explain the drop in the hire rate that predates the election of Barack Obama.

The Obama administration has done at least a respectable job, and maybe much better than merely respectable, on the demand side in trying to end the recession. They do not seem to see need to do anything on the supply side, which does create an interesting test for economics.

What will stop the recession?

A few days ago Carpe Diem had a post on two views of what is bringing us out of recession. One view said it was the self-stabilizing nature of markets aided by massive Federal Reserve action, the other argued big government, especially automatic fiscal stabilizers. One of the weaknesses of macroeconomics is that it is so hard to test different theories.

I could not resist the temptation to add a couple comments, but forgot that the word "data" is plural.

The supply-side case against Obama

In his "War Against Producers", Victor Davis Hanson makes the supply-side case against Obamonomics:

And that means rippling throughout this key sector of the economy — even before these taxes have been enacted — are hesitation, stasis, and ultimately constriction — at first for psychological reasons, soon confirmed by the actual facts of less money. In short, very bright people will be thinking how to hide income, how to barter, how to slow down and not produce goods and services, rather than blast full speed ahead and enrich angry others.

How well is that stimulus working?

President Obama (or his speech writer) has a column in the Washington Post defending his economic policies. He uses one of his favorite rhetorical devices:

They favor an incremental approach or believe that doing nothing is somehow an answer. But that is exactly the thinking that led us to this predicament.

His critics are not impressed. Here is Stephen Spruiell on The Corner

We should not allow Obama to take credit pre-emptively for any future recovery when there is such a strong case to be made that his policies created a level of uncertainty that prevented the recovery from starting sooner.

Keith Hennessey does an almost sentence-by-sentence critique:

This did not have to be a two-year program. Congress could have front-loaded the stimulus had they instead given the cash directly to the American people, as they did on a bipartisan basis in early 2008. We would have saved much of it, paying off our mortgages, student loans, and credit cards (which would not be a bad thing). We would have spent the rest much more quickly than the federal and state government bureaucracies now stumbling through their usual corrupt, slow and inefficient processes. Instead the President handed the money and program design over to a Congress of his own party, who saw it as a big honey pot rather than as an exercise in macroeconomic fiscal policy. The President’s primary macroeconomic policy mistake was allowing Congress to pervert a rapid Keynesian stimulus into a slow-spending interest-based binge.

Finally, Ed Morrissey at hotair.com:

Note too that Obama has quietly dropped the promise to “save or create at least 3 million jobs by the end of 2010,” as Romer’s support of Porkulus claimed. Nowhere in this essay does Obama put a number on jobs. Suddenly, Porkulus has stopped being a jobs project — the entire basis on which Obama pushed Congress to pass it — and has become instead a foundational, long-term rebuilding of the American economy.

Laffer, Blinder, and Perry on the danger of inflation

Laffers says yes, Perry and Blinder no in the continuing series of excellent posts at Carpe Diem.

It was the economy, stupid.

James Pethokoukis in his Reuter's blog on Obama and the recession:

Obama took a tremendous economic and political gamble last January. The new president had the option of putting forward a stimulus plan that would attempt to reverse or significantly dampen America’s terrible economic downturn ASAP. The quickest and most effective approach would have been a big cut in payroll taxes.

Instead, Obama chose to listen to Rahm “Never let a crisis go to waste” Emanuel and put forward an $800 billion plan that advanced his healthcare, energy and education policy goals — but pretty much neglected the economy in 2009. Team Obama had to fully understand this.

The gamble appears to have failed miserably, both economically and politically.

There was a lot of rhetoric about how serious the economic problems were, but in retrospect, it seems to have been mostly rhetoric. The focus of the Obama administration has not been on getting out of the recession as quickly as possible. They have had other priorities. It will be interesting to see how it plays out.

Update: Arnold Kling argues that the "Obama Administration appears to me to be pursuing many goals, poorly." In a year and a half we will see if their failure to prioritize costs them.

Jobs created or saved

William McGurn writes in The Wall Street Journal about the notion of jobs created or saved, quoting Greg Mankiw:

"The expression 'create or save,' which has been used regularly by the President and his economic team, is an act of political genius," writes Mr. Mankiw. "You can measure how many jobs are created between two points in time. But there is no way to measure how many jobs are saved. Even if things get much, much worse, the President can say that there would have been 4 million fewer jobs without the stimulus."

How does fiscal policy work

The rise of long-term interest rates since the beginning of the year has drawn notice. Niall Ferguson notes that he predicted the rise while Paul Krugman, relying on textbook Keynesianism, did not:

Of course, Mr Krugman knew what I meant. “The only thing that might drive up interest rates,” he acknowledged during our debate, “is that people may grow dubious about the financial solvency of governments.” Might? May? The fact is that people – not least the Chinese government – are already distinctly dubious. They understand that US fiscal policy implies big purchases of government bonds by the Fed this year, since neither foreign nor private domestic purchases will suffice to fund the deficit. This policy is known as printing money and it is what many governments tried in the 1970s, with inflationary consequences you do not need to be a historian to recall.

Over at Econlog Arnold Kling also notes the rise:

Greg Mankiw reports that the yield curve is steep, meaning that long-term interest rates have risen. In my view, this is perfectly rational, and it shows that the short-run effect of the fiscal stimulus is negative, as Jeff Sachs predicted.

This is all based on a Keynesian type of macro analysis. As we know, most of the stimulus spending does not take place until next year and beyond, so the short-run gains are puny. On the other hand, the big increase in the projected deficit creates the expectation of higher interest rates, which raises interest rates now. These higher interest rates serve to weaken the economy.

I keep seeing this graph

I keep seeing this graph at Instapundit and other sites. Numbers often say more than words.


Here is a youtube video giving the story in a different way:



Update: At least one person is the mainstream media is concerned. Robert Samuelson at the Washington Post writes:

From 2010 to 2019, Obama projects annual deficits totaling $7.1 trillion; that's atop the $1.8 trillion deficit for 2009. By 2019, the ratio of publicly held federal debt to gross domestic product (GDP, or the economy) would reach 70 percent, up from 41 percent in 2008. That would be the highest since 1950 (80 percent). The Congressional Budget Office, using less optimistic economic forecasts, raises these estimates. The 2010-19 deficits would total $9.3 trillion; the debt-to-GDP ratio in 2019 would be 82 percent.

Except from crabby Republicans, these astonishing numbers have received little attention -- a tribute to Obama's Zen-like capacity to discourage serious criticism.

A clever map showing job changes

Here.

Meltzer on the Fed

Alan Meltzer, who having written the longest and most detailed history of the Federal Reserve is an authority on the Fed, was on the editorial page of the New York Times Sunday worrying about inflation in our future. He notes that it is possible that the Fed will withdraw the huge amount of liquidity it has created in the past several months, but he worries the political pressures will stop it.

I do not doubt their knowledge or technical ability. What I doubt is the commitment of the administration and the autonomy of the Federal Reserve. Mr. Volcker was a very independent chairman. But under Mr. Bernanke, the Fed has sacrificed its independence and become the monetary arm of the Treasury: bailing out A.I.G., taking on illiquid securities from Bear Stearns and promising to provide as much as $700 billion of reserves to buy mortgages.

Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation.

When will it come? Surely not right away. But sooner or later, we will see the Fed, under pressure from Congress, the administration and business, try to prevent interest rates from increasing.

Meltzer is always worth reading. Read the whole thing.

Update: Krugman responds, and Meltzer replies.

Another update: Melter again.

A third update: Melter on the Enterpriseblog:

Can the Fed control inflation? Absolutely. Will the Fed control inflation? Unlikely. The Fed will face political pressures. It has sacrificed much of its independence and will have a hard time getting it back.

Anna Schwartz on the recession

From City Journal, Anna Schwartz on the current economic recession:

The credit crunch, which is the recession’s actual cause, comes only from a lack of trust, argues Schwartz. Lenders aren’t lending because they don’t know who is solvent, and they can’t know who is solvent because portfolios remain full of mortgage-backed securities and other toxic assets.

“The worst thing for a government to do, though, is to act without principles, to make ad hoc decisions, to do something one day and another thing tomorrow,” she says. The market will respond positively only after the government begins to follow a steady, predictable course. To prove her point, Schwartz points out that nothing the government has done to date has really thawed credit.

Schwartz indicts Bernanke for fighting the wrong war. Could one turn the same accusation against her? Should we worry about inflation when some believe deflation to be the real enemy? “The risk of deflation is very much exaggerated,” she answers. Inflation seems to her “unavoidable”: the Federal Reserve is creating money with little restraint, while Treasury expenditures remain far in excess of revenue. The inflation spigot is thus wide open. To beat the coming inflation, a “new Paul Volcker will be needed at the head of the Federal Reserve.”

Money illusion blog

Here is a new blog on monetary policy that looks interesting. I have not had the time to look at it closely yet.