[Pen-l] John Judis in the New Republic on Obama's choice for the CEA

["Jim Devine" <jdevine03@xxxxxxxxx>]

>>with my comments<<

John Judis:

Barack Obama announced today that the chair of his Council of Economic
Advisors will be Christina Romer, a professor at the University of
California, Berkeley, and an expert on government fiscal and monetary
policy. As Romer stood beside him at the press conference, Obama
uncharacteristically stumbled over his words in introducing her. He
seemed to be learning who she was as he spoke--and that may say more
about the appointment than the actual words of praise he uttered.

>> It may be a mistake to generalize from economists' past performance. The current juncture is quite different from the past, so that most of them change. (For example, even the most conservative types think deflation is a bad idea now.) I've seen Romer speak and she seems smart, BTW. (She had a miscarriage and had to end the talk early, but that's another story.) Nonetheless, I geneally agree with Judis's critique.

>> What's most important to me is that the balance of political power has not shifted much at all toward labor and other dominated groups. So Romer, Summers, etc., may be as good as we can expect.<<

Obama has been criticized for excluding progressive Democrats from his
administration. I think that's nonsense. But in this case, Obama did
appoint someone--whether wittingly or not--whose views on the economy
appear to place her well to the right of mainstream Democratic
economic opinion. I say they appear to do so, because my basis for
saying this is not pronouncements that Romer has made on what to do
now, but her theories about fiscal and monetary policy.

Start with her views on the Great Depression of the 1930s. The
standard account has been that the U.S. economy began to revive from
1934 to 1937, when Franklin Roosevelt's government hiked public
investment and ran budget deficits; that the recovery stalled in 1938
after Roosevelt erroneously put the breaks on the economy and tried to
run a surplus; and that the country only recovered from the depression
after that because the U.S. began running deficits again and because
of growing war orders from abroad; and that the final recovery awaited
the massive public defense investment in 1941 and 1942. Gross public
investment increased 150 percent from 1940 to 1941, and that's when
unemployment began to plummet.

Romer's view is that what ended the depression was an expansion in the
monetary supply, due to the inflow of gold from abroad. "Fiscal
policy, in contrast, contributed almost nothing to the recovery before
1942," Romer wrote in a 1991 paper for the National Bureau of Economic
Research. That's a view that would lead one to emphasize monetary over
fiscal fixes--that is, changes in the federal funds rate and money
supply over increases in public investment and cuts in taxes. This
policy perspective would seem to de-emphasize or even oppose the kind
of massive public investments that Obama now seems to be considering.
If so, Romer would be encouraging a strategy that has so far proved
ineffective--Fed interest rates are approaching zero and the economy
is continuing to crater--and rejecting a measure that might be
effective.

>> It's going to be very hard to emphasize monetary policy when it's clearly hitting its limits (such as the zero-bound on nominal interest rates). <<

In a paper delivered in September 2007, Romer addresses more directly
recent government fiscal and monetary policy--but with the same
implications. She contends that after World War II, the Truman and
Eisenhower administrations developed a "modern" fiscal and monetary
policy that was remarkably successful. It stressed a commitment to
budget surpluses to prevent inflation and the use of deficits only in
the extremity of a recession. During the Kennedy and Johnson years,
Romer argues, the U.S. abandoned this approach for one that sought to
maintain low unemployment (a four-percent target) through, if
necessary, persistent budget deficits. Romer contends that the '60s
model led to the high inflation and unemployment of the '70s.

>> The original philosophy was called "functional finance," by the way. The Kennedy administration did not abandon it completely. She's wrong about it causing the high inflation. Rather, it was the Viet Nam war (wiht its big spending and draft) that had this effect -- along with LBJ's inability to raise taxes enough. (He just didn't have the political clout and had to pull out of the re-election race.) Monetary policy, by the way, played a very passive role because it was trying to keep the US dollar exchange rate fixed. When it stopped being fixed, that encouraged inflation (though it wasn't the only cause). The fixed exchange rate had set a ceiling on US inflation. The US was breaking that ceiling and chose to deal with the problem by abolishing it. The flexible exchange-rate system allowed inflation: there was no longer a direct consequence arising from having inflation that was faster than that of trading partners.<<

According to Romer, fiscal and monetary policy partially returned to
the successful strategy of the 1950s after Ronald Reagan's election in
1980. She cites Federal Reserve chief Paul Volcker's attempt to kill
off inflation through inducing the steepest recession since the 1930s.
Since then, government policy toward the business cycle has been ceded
to the Federal Reserve, which has contracted the money supply when
unemployment has been reduced to a "natural rate" under which it would
encourage inflation. This policy, she writes, "particularly on the
part of the Federal Reserve, is directly responsible for the low
inflation and the virtual disappearance of the business cycle in the
last 25 years."

>> R's view is BS. The Reagan strategy was very much like JFK's, since it involved fiscal stimulus of demand. (Perhaps unlike JFK's strategy, it had no supply-side impact.) Volcker's strategy was the start of the "inflation targeting" era (keeping inflation down and letting the unemployment chips fall where they may). Inflation did get hurt by Volcker's strategy (though he had to relent in 1983) but he benefited dramatically from the collapse of OPEC and thus falling oil prices (despite rising demand) circa 1986, which doesn't seem to be the result of his policy. It was luck.

>> In the 1990s, inflation was kept down by the high dollar exchange rate (which privileged US foreign competitors, keeping US firms from raising prices) and the general one-sided war against labor since the 1970s (which ended the wage/price spiral). In the 2000s, the exchange rate has generally fallen, encouraging US exports and inflation, but relatively slow aggregate demand growth (and the continuing war against labor) has prevented inflation from rising outside of commodities like oil and food.

>> The business cycle may have "disappeared," but it's become pretty obvious that it was _delayed_ instead. Policy-makers shoved the problem into the future. And the future is now. <<

Here is Romer again on the success of the Fed:

"Overall, the story of stabilization policy of the last quarter
century is one of amazing success. We have seen the triumph of
sensible ideas and have repeated the rewards in terms of macroeconomic
performance. The costly wrong turn in ideas and macropolicy of the
1960s and 1970s has been righted and the future of stabilization looks
bright."

This was said, it must be stressed, only a year ago, when signs of
incipient downturn and financial disaster were already apparent to a
good many economists. Romer's opinions in this case suggest that there
may be something wrong with her overall point of view.

>> Romer, like many economists, fell for the "new era" optimism of the 1990s and never escaped it.<<

I'll leave it to better minds to pick apart her economic theory. I'll
just make two points about her argument. First, her history is
misleading. She singles out the "1950s" as an Eden of economic policy
and performance. She acknowledges later that "there were two
recessions in the 1950s, and that in 1958 was quite deep," but even
that acknowledgement is insufficient. Yes, it is true if you define
the "1950s" literally as 1950 to1959; but there were four recessions
from 1948 to 1960. One of the reasons John Kennedy won the election in
1960 was because Americans--once again suffering from a downturn--were
sick of repeated recessions and wanted "to get the country moving
again." Kennedy came into office with a mandate to fix fiscal and
monetary policy.

>> Right. But most economists don't care that much for democratic mandates. The neoliberal orthodoxy storms at "populism" and wants our economy managed by "technocrats" who are not held responsible to the citizenry.<<

The history since then has been considerably more complicated than
Romer makes out. Kennedy's economic policies were by no means
unsuccessful. Unemployment fell from seven percent when Kennedy took
office to 4.8 percent in November 1964 without provoking a rise in
prices. What took place afterwards were disasters--most of which Romer
does not mention, but which made Kennedy's brand of aggressive
Keynesianism more difficult to pull off: the Vietnam War (along with
Johnson's reluctance to finance it through tax increases); the growing
competitiveness of foreign producers that threatened, and finally
undercut, America's trade surplus; the huge spike in international oil
prices (which Romer discounts as a major cause of inflation); the
collapse of Bretton Woods; and the peculiar arrangement that the U.S.
created with Japan and later China that allows them to run budget and
trade deficits without raising interest rates.

>> Right. <<

None of this suggests that the U.S. should go back to the fiscal
strategy of the '60s--the circumstances now are utterly different. But
it does suggest that the answer may not lie in a return to
Eisenhower's fiscal and monetary strategy of the '50s or to Romer's
version of the post-1980s monetary strategy. If Romer's views of
September 2007 are applied to November 2008, what do we get? Deficits,
but with an eye toward surpluses, and an emphasis--going back to her
article on the Depression--on monetary rather than fiscal expansion as
the solution. If that is, indeed, what Romer advocates, that's
probably not the change we need--or that Obama has promised.

John B. Judis is a senior editor at The New Republic and a visiting
fellow at the Carnegie Endowment for International Peace.

>> He used to be a leftist of some sort.<<
-- 
Jim Devine /  "Nobody told me there'd be days like these / Strange
days indeed -- most peculiar, mama." -- JL.
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