Brad DeLong and Tyler Cowen are having an argument.
Brad argues that because interest rates are low in the US, the government should borrow more money:
Otherwise, the purpose of a market is to tell you what things are valuable so that you can make more of them. Right now with the decline in interest rates on government debt the market is telling us that government debt is more valuable than it was last week. So we should make more government debt–pull spending forward from the future into the present and push taxes back from the present into the future.
In my view, a low rate of interest on Treasury securities indicates a high chance that the investors will be paid back. That is all it means. It is not a market signal that the government output should be produced.
Brad answers and says yes, it is a signal that the government should produce more:
If the price of something–in this case, government production–goes down, as it has in the aftermath of the earthquake-and-tsunami as U.S. Treasury interest rates have dropped by 10 basis points, shouldn’t you buy more of it? Yes.
It is true that the world is poorer as a result of the earthquake–poorer by perhaps $100 billion as a result of all the destruction. And a poorer world should buy less of everything. But the U.S. is not poorer: we should not buy less of anything.
So it is very clear to me that the U.S. government should spend more.
Another Keynesian mystery for me. A lower interest rate doesn’t mean that government production is less expensive. It means government borrowing is less expensive. The cost of government spending is foregone private spending. Maybe the government should be bigger. Maybe we don’t have enough interstate highways or Mars manned space missions while everything else is at just the right level. So government should be bigger. The only way this makes sense is the Keynesian idea that when there is excess capacity, government spending is a free lunch–there is no foregone private output or if there is, the lower interest rate says there’s less foregone private output.
Think about it at the personal level. Does a lower price of debt mean I should borrow more? Live further beyond my means? It does not. It might mean I should make a lower down payment and borrow more for my car or house. But even that doesn’t automatically follow.
Yes, to the extent that mortgage rates drop, people can afford to buy bigger and more expensive houses.
And they should do so.
To argue that people should not respond to falling mortgage rates by buying bigger houses is simply silly, like arguing that people should respond to falling computer prices by buying fewer and simpler computers or should respond to falling clothes prices by making more of their own garments.
It’s true it would be silly to respond to lower clothes prices by making more of your own garments. But it would be equally silly always to buy more shirts when they get cheaper. It’s nice to have more shirts than fewer shirts. I like choice. But it would be a mistake to keep expanding my stock of shirts just because the price of shirts goes down. At some point, even though shirts are cheaper and more choice costs me less than it did before, the benefits of additional choice is offset by the cost of the other things I give up when I acquire another shirt.
When interest rates are lower, borrowing to finance public spending is cheaper. So what? It’s also cheaper to finance future private consumption. Brad is implicitly arguing that another bridge or road or bigger payments to farmers or expanding the US military doesn’t mean less of something else. He also seems to forget that the world is an uncertain place. Buy the bigger house or spend another trillion and you may find yourself in an unexpected situation that is not pleasant.
by Russ Roberts
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Save now! Stuff on sale!
Doesn’t matter if you need it or not.
The more you buy, the more you save!
I can’t help but think of this.
…buy as much as you want! We’ll print more!
Brad is trafficking in a bizarre kind of moralism and nonsense, not economics. Economics does not tell us what people “should” do in response to changes in prices. Lower mortgage rates doesn’t indicate that I “should” buy a bigger house. Cheaper per-unit prices for campbells soup by the crate at Sams Club doesn’t tell me that I “should” buy a crate of campbells soup.
The only thing which determines what each of us “should” do is what each of us chooses to do based on our own individual ends and the mean and opportunity costs we confront. I may be facing lower mortgage rates, but have a plan to start a new business, which is risky. Loading up on a bigger mortgage may not be what I “should” do, if my ends are to be successful and save sufficiently to weather a slow patch in my start-up.
Brad doesn’t believe he’s a socialist. But his argument for more “government production” is no less subject to the problems of socialist calculation than any other instance. The fact that it’s cheaper for the government to borrow money for the production of corn-based ethanol does not make said production good. It sucks. Government production is mostly war and waste and fraud. Lower borrowing costs for it doesn’t change what it is.
Brad isn’t a socialist. He simply thinks he knows what’s best for everyone under given economic indicators/conditions….whether he intends it that way or not.
It’s one thing to say that economic signals tell people, in a manner of speaking what they can or cannot do….or….should or should not do. However, the precise details of those possibilities change for everyone so there is no point of reference to make claims for everyone.
It’s quite another to say what Brad says.
And yes, the idea that what can be done in terms of capacity, SHOULD BE done is a flaw of Keynesian thinking. Nobody is a Keynesian in their personal life. We don’t do everything that we possibly could in a day. And trying to do so wouldn’t even be a good thing. At some point, we stop doing what we want and start crowding out time for rest and reflection for how to spend time tomorrow and beyond…something that can be difficult or impossible with forced activity today.
Agreed! Could vs. Should. There’s a whole heaping world of difference between those two judgements… unless you see the world as nothing but a flow of spending.
I agree with you John. Individual choice based on personal knowledge of individual circumstances should drive honest and moral individual decisions.
John, I’m glad you and Russ are pointing out opportunity cost here… someone needs to!
You said it very well. It boggles the mind that more than a decade into the twentyfirst century there are still dolts who do not understand the basic concept of opportunity costs. And that they are considered “experts”.
Since we are talking about Tyler Cowen, I thought I’ll post this link about Tyler
WOW! I actually remember that blog post. That is too funny.
Tyler is such an enigma sometimes. For someone who has picked at ABCT so often, he sure knows how to use it correctly. It makes you wonder, in this case, if he takes being right as being wrong. Quite a pickle he’s in.
I agree with Tyler. To be more specific, a low interest rate on government debt reflects the government’s ability to force people to pay taxes.
The mistake in DeLong’s mortgage analogy is that the price of homes rise when mortgage rates drop, so borrowers can’t necessarily afford bigger homes.
Brad works out one step at a time. Be patient.
Yep. This is too elementary for Brad to misunderstand. He was probably thinking “take a bigger mortgage” as a percentage of the total cost of the house. You know, those zero-down mortgages were such an awesome idea!
I know people who can not get past the mentality of, “a loan means I have more money!” “I was approved for X, I’ll spend X,” even if X/2 is more in line with what they can afford. Every one of them can not figure out why they are broke and never seem to be able to catch up or get ahead.
The purpose of debt is to accumulate the stuff you want in life. DeLong thinks the purpose of life is to accumulate all the debt you can, then figure out how to spend it.
Reducing future spending is not in and of itself a good thing. It is a cost. To be able to get the stuff you want now, and not reduce as much future spending, is desirable.
Is Brad confusing demand and quantity demanded, perhaps?
The price of real estate has declined. Does that mean quantity demanded should increase? Uh… Or does that imply that demand has DECREASED causing the price to drop?
A falling price is not necessarily a signal to buy more. It could be a signal to buy LESS!
If quantity is falling along with price then you can say, with certainty, that demand has fallen (ie. consumers think its a bad deal).
I recently read a Wall Street Journal article by a clown that argued that rising oil prices will cause falling oil prices (because a rise in price will curtail demand). Amazing.
Oh you with your econ 101 confusions and such. Brad thinks that during a period of unemployment, “anything” which raises the government’s deficit is good. No need for such marshallian curve talk when a world free of prices and scarcity is within our grasp. Prices? Who needs prices during a liquidity trap?
In this case, government’s demand for loanable funds is a vertical curve that is always increasing with time. When the price the gov has to pay for those funds drops, you can rest assured it is because the available supply of loanable funds to the Treasury is increasing.
Of course, part of that supply comes right off the Fed Reserve’s printing presses.
…when demand (FRNs) comes via keystroke entry and supply (T Bonds) comes via congressional vote, it takes an Ivy League PhD to make sense of it all.
Not exactly.
It is easy for the government to take on debt to spend when the debt is paid by others… I would like to know the opinion of taxpayers… They’ll have to pay that debt… or not…?
Gee, thinking about the poor taxpayer? That would never occur to an elitist Keynesian.
Does the effect of the Federal Reserve setting interest rates artificially low not enter into this conversation?
Brad writes:
“a low rate of interest on Treasury securities indicates a high chance that the investors will be paid back.”
Does it? Interest rates are inversly related to price. A rising bond rpice implies a falling rate. If demand is rising, then bond prices will rise thus reducing the rate. But this begs the question: Where is the increased demand coming from? Profit-seeking individuals carefully evaluating information and expectations? Or the whims of the bureaucrats turning the central bank printing press?
It sort of means exactly that. Low yields on Treasuries indicate that the market believes they are a safe investment. It’s another way to say that lenders expect to be repaid. A falling Treasury yield indicates rising confidence not only that bondholders will be repaid but that other investments are increasingly worth forgoing.
Where is the increased demand coming from? Profit-seeking individuals carefully evaluating information and expectations?
I don’t know where all the demand is coming from, but some of the demand is surely coming from portfolio managers switching out of European and Japanese debt and into Treasuries because they now take the view that Treasuries are relatively more secure.
The Treasury bond market is among the most liquid markets in the world. It’s a difficult market to control by a single entity and it is ultimately “controlled” by the market, not the Fed. The more liquid the market, the tougher it is for a single entity to control and the tougher it is to argue with the current price. You may remember in 2008 when Treasury yields got hysterically low as investors flooded out of ever riskier investments and into the safety of Treasuries.
The Treasuries market, is different from the corporate bond market in a particularly vile way. Corporate debt is paid off with corporate earnings and the bet a corporate bond investor makes is that the company will create enough wealth to pay them the amount agreed upon in the future. It’s a voluntary agreement between to parties. The Treasury bond investor makes the bet that Americans will produce enough wealth in the future to pay off the bond and that government will be able to confiscate it from them!
One thing I find kinda interesting. Recently PIMCO, one of the largest fixed income funds (if not THE largest) in the world, announced that it has divested all of its Treasury holdings. Bill Gross announced recently that PIMCO no longer holds any U.S. Treasuries in any of its portfolios because they do not view Treasuries as a sound investment. Take it for what it’s worth, but I do at least find it interesting that a company with hundreds of billions (it may be a trillion by now) under management cannot find a reason to allocate a single penny to the most liquid securities in the world.
>The Treasury bond market is among the most liquid markets in the world.
Exactly. The Japanese situation has triggered a whole series of moves in the market. The Yen is used extensively in carry trades. When something like this happens, people liquidate their positions and park their cash in Treasury bonds. They know they can buy and sell easily in the liquid market.
Delong is showing his ignorance.
Ah, yes the carry trade. The people who don’t understand interest rate parity are now signaling DeLong that they want the U.S. government to produce more bridges to nowhere.
It is easier to think in terms of the borrower (the Treasury) as the demander of a quantity of loanable funds, who pays the supplier (those who buy Treasuries) an interest rate price.
Then it is clear that a low rate of interest (low price) means either the Treasury is borrowing less (cold day in hell), or people are providing the Treasury with a greater supply of loanable funds.
That MAY be because regular folks like you and me think the risk-return profile for Treasuries has improved relative to other investments. But it may also be because the Fed Res is engaging in QEx.
The economics way of thinking is foreign to DeLong and maany other “economists”.
One wonders why folks who can’t think economically should still be called “economists”.
We don’t call people who can’t think logically “logicians”.
Greg,
There are many reasons why many of the non-economists who are called “economists” continue to be so named. Here are my top 5:
5) Economics textbooks are now often written by “economists”
4) Economics is no longer a required core class at most universities; at many universities “Economics” classes have crowded out Economics
3) Graduate training in Economics is now training in “Economics” at most universities
2) The top journals in Economics are ever more interested in publishing lemma-laden modls (“Economics”) and ever less interested in publishing criticisms of past publications (there is explicit “hostility” by editors at top journals toward comments, replies and rejoinders). One caveat here: Thank God for Dan Klein’s forum, EJW, where economists CAN critique “Economics”.
And the NUMBER ONE reason:
1) There is a market for “economics”; by selling out the economics discipline to politicians, lefty lobbyists, and granting agencies so often dominated by PC leftists, “economists” make more than economists writing for EJW, Cafe Hayek, the Freeman, the Independent Review, Cato, and so forth.
Brad made one good point in his original post, but he took the wrong lesson from that good point, and then followed Tyler down the rat-hole of arguing the wrong lesson.
Brad’s original [good] point is that if government borrowing is cheap, it may be better to finance some of our spending through borrowing than through taxes.
This point makes sense on several levels. On a personal level, when borrowing is cheap, fixed, and long-term, it makes sense for me to perhaps put a small down payment on a house in order to purchase today rather than rent for years while building a 20% down payment. After all, I have to live somewhere, and if I buy a home that’s priced at rental parity it’s silly to rent and pay extra to save for that down payment when I can buy earlier and actually apply my principal payments to building my own wealth? If the marginal difference between 3.5% down and 20% down is, say, $100K, it’s pretty easy to decide based on the interest rate whether I’m going to lose wealth faster paying debt service on that $100K than I would gain by putting that small pittance of my monthly mortgage check to principal during that time. Pulling [necessary] spending forward when borrowing is cheap [and fixed-rate and long-term] may make more sense than forgoing that spending today — especially if you think borrowing costs will rise in the future.
The proper takeaway from that is that if government spending level X is appropriate, and is larger than current tax revenues, a low T-bill interest rate (presumably on 10- or 30-year notes, which is what you want to sell) is a signal from the market that deficit spending might be a better idea than raising taxes. A high T-bill interest rate is a signal from the market that you should pay for that spending today with taxes rather than borrowing. That makes sense, particularly if you think the economic prognosis is good and you can expect an expanded tax base in the future.
Where DeLong goes off the rails is stating NOT that a low T-bill rate suggests that borrowing might be a better way to finance gov’t production than taxes, but in suggesting that a low T-bill rate suggests we should INCREASE gov’t production. One does not follow from the other. As Russ points out, seeing that shirts are on sale doesn’t mean that you should buy shirts you don’t need; rather it simply means that if you need a shirt you should buy it today rather than wait for the sale to end.
Brad’s original [good] point is that if government borrowing is cheap, it may be better to finance some of our spending through borrowing than through taxes.
You’re wrong for two reasons. The first is that borrowing or taxing are not government’s only two options. It can also cut spending. The second is that government borrowing is a tax. Each bond issued by government is an entitlement to your earnings.
I think you’re making some common mistakes in your rent vs. buy decision. You assume that renting is a waste of money. It’s not – unless you don’t value roof over your head.
You also leave important considerations out of your analysis. When you rent you are long an option to move quickly. The value of that option depends on how much you value the ability to move to take a job in another city, to move to a cheaper dwelling should the need arise, or to move to a nicer neighbourhood without having to endure the pain and massive transactions costs associated with selling a very illiquid asset.
You assume that you will be building wealth, but you fail to account for the price risk when you buy an asset (especially a very illiquid asset). There is no guarantee that buying a house will build your wealth. You may very well find yourself in a situation where the house is worth less than you paid for it.
The item I find people most often leave out of their calculation is the opportunity cost of the downpayment. That potential downpayment is not sitting around in your mattress. You would invest it.
I haven’t done it in years, but we used to run this calculation for fun with people who claimed that renting was “throwing money away”. Turns out that, assuming a 20% downpayment, and a thirty year mortgage, the difference between renting and buying is zero. That is, you don’t win financially by buying. However, you may still wish to buy for many reasons – you can’t find the same house for rent, the option to move quickly is not valuable to you, you get satisfaction from the knowledge that you own, etc. All those things are personal reasons that can be properly valued only by you (ahem, Keynesians!). It’s just that financial gain isn’t one of the reasons to own instead of rent….. UNLESS you can get a zero-down mortgage (or something close).
If you can get a zero-down or very low downpayment mortgage, that changes EVERYTHING. With a zero (or close to zero) down mortgage you are basically renting to own. Gloriously (for you) zero-down mortgages come with a free (to you) put option. You can walk away from your mortgage without losing a down payment. Literally, you can put the the mortgage back to the hapless mortgage lender any time you please. Plus, you no longer have an opportunity cost of a downpayment to worry about when making the rent vs. buy decision.
Which brings us back to good ole’ Brad D. Delong and DeShort of it is that mortgage rates are by far not the only decision that goes into buying a house and – if Brad meant “decrease your downpayment” – that lowering lending standards while manufacturing an artificially long time horizon is just plain destructive (see recent housing boom and bust). Even if, as economists are want to do sometimes, we hold everything constant to isolate changes in mortgage rates, the reduction of the downpayment is just plain stupid for the lender/taxpayer.
[Nice blog, btw, Warbiany!]
Thanks for the compliment on the blog
You bring up good points, but we assume that the “desire to buy a house” and the “government should spend X that they are spending today” is already made. I, for one, believe that government spends too much and thus would rather they reduce that spending. I also see your point that if, say, you already have a 20% down payment for a house, but someone is offering you a loan at a low rate w/ only 3.5% down (i.e. FHA), it might make more sense to invest the rest of that down payment elsewhere if you can earn more in interest than the bank would charge you to borrow it. And I see your point that a lot goes into the rent vs. buy decision that I couldn’t cover in my already-long comment.
The entire point is if the cost of OPM is low, it might make good sense to use OPM to do *what you already need to do*. Not that it should induce you to do something you don’t need to do.
Methinks, do you still have the calculation? I love seeing things like that.
I think it’s an excel file on a floppy disk (yes, you read that right) somewhere in my archives. I’ll try to find it and email it to you, foxy.
I’d love to see it too, if you don’t mind forwarding it to me as well.
Sure, Michael. Email me at Methinks76@gmail.com so I have your email.
“The cost of government spending is foregone private spending.” I can’t believe Russ still writes this. I really cannot. After DeLong has explained the macro so many times on his blog.
If there is no private spending, because people are…..well……not spending, then there is no cost of government spending. Not in terms of crowding out private spending at least, there may be other costs.
Again, I recommend you check out Benjamin Friedman’s paper ‘Crowding out or crowding in?’
As for the analogy on “the personal level”, well again I must quote Einstein: “Make everything as simple as possible, but no simpler”. To analyse the situation with one isolated individual is to simplify too much. There are other people besides one individual in an economy. What that individual chooses to buy (or not buy) has consequences for those other people too.
“If there is no private spending, because people are…..well……not spending, then there is no cost of government spending. Not in terms of crowding out private spending at least, there may be other costs.”
Vic Caspian is a well known successful venture capitalist looking for an investment. One week Andy comes into his office and pitches an investment. Vic decides it’s a bad idea, and turns him down. The next week Bob pitches his idea. Vic again decides against it. The week after, Craig pitches his plan. Vic considers it carefully, and agrees to invest his funds with Craig.
Are you saying that if Uncle Sam comes into the office just as Andy is sulking out, and offers Vic a t-Bill deal he can’t refuse, there is no crowding out? What about Craig?
People erroneous think that investing is the spending that investors do. In fact, investing is the CHOOSING investors do. Give me 10 minutes, and I’ll give you a 10 line algorithm telling you how to spend. That doesn’t make me an investor.
So what does Uncle Sam do? He creates whatever deal he must to get Vic to lend him the money, to be paid back at future taxpayer expense (prosperity hit #1). Then Uncle Sam turns around and spends that money on Andy’s losing idea (prosperity hit #2). Craig never even happens (prosperity hit #3).
When an investor decides not to spend his money, consider the possibility that NOT spending is the best choice at that time.
If you could only imagine how much capital is sitting on the side lines because of what the government is doing, it would blow you mind.
That may not be ‘exactly’ the term for crowding out, but the effects are the same. Close enough for government work anyway.
Any way that you or Delong dress it up, government debt is both a lost opportunity cost, and a demand upon future wealth.
Furthermore, not all Government spending is wasteful or non-productive, but most of it is, (some is even malevolent in regards to business and commerce).
And finally, excessive government debt causes a lack of business confidence that also negatively effects investment decisions.
If people aren’t spending (as much) perhaps its because they are getting signals that they should save instead (forgo consumption).
Tell me what’s wrong with that.
“The Paradox of Thrift”!
Bad foundation, bad ideas.
Because that would tend to concentrate capital on the few remaining good investments. And that wouldn’t be fair to all those wasteful hairbrained schemes fueled by the prerecessionary bubble.
….which reminds of another argument DeLong made: if you say “The cost of government spending is foregone private spending”, why can’t you just as well say “The cost of private spending (by A) is foregone private spending (by B)”?
Why must public spending come at the expense of private spending, but ‘other’ private spending must not?
“Why must public spending come at the expense of private spending, but ‘other’ private spending must not?”
All actual spending is some other foregone spending. That’s not the point. You present an argument that could only come from someone who doesn’t see an important distinction between private and public spending.
exactly. i don’t. the crowding out argument doesn’t make a distinction between types of spending.
most commenters here argue that public spending is almot always wasteful. that may well be. (incidentally, provate spending can be wasteful too). but that has nothing to do with the crowding out argument. what russ says is that someone borrows to spend then that means someone else can´t spend. and that is just flat wrong.
i modern financial economists the same quantity of money serves to complete more than one transaction: if i have $100 in my savings account i can spend all of that, but the bank has also loaned it out to someone else
Of course private spending includes a lot of wasteful spending. Trial and error produces error (waste). The difference is that waste by private enterprise results, ultimately, in bankruptcy. The wasteful spender disappears. In government, wasteful spending is an invitation to spend more. How many government programs are shut down because they are found to be wasteful?
And as long as we’re on government incentives, I can’t really think of a time when government didn’t think it was receiving a signal to spend, regardless of interest rates. Does government “production” decline when yields rise to 7% and rise when yields are 2%. I wonder if you happen to know.
“The difference is that waste by private enterprise results, ultimately, in bankruptcy. The wasteful spender disappears.”
But the lessons linger. And that’s progress in terms of knowledge.
Everything that we take for granted was done the wrong or in an inferior way many times before someone got it right. It’s all a process.
But the lessons linger. And that’s progress in terms of knowledge.
A concept completely foreign to government bureaucrats. In government, it’s the waste that lingers and the lessons and knowledge that die.
“Trial and error produces error (waste). The difference is that waste by private enterprise results, ultimately, in bankruptcy.”
True. So how is that difference relevant to the crowding out argument?
True. So how is that difference relevant to the crowding out argument?
How is it not relevant? Are resources not scarce?
modern financial economists the same quantity of money serves to complete more than one transaction:
Sure it does. What you don’t understand is that no one borrows money so that they can take it home and burry it in their background. They do it to employ resources in some manner. You can’t see beyond the fluttering veil of money. The resources that it can claim are really limited. R&D project on green energy is not going to employ unemployed Real Estate Agents, former Sales Clerks at Home Depot, unemployed Mortgage trader, or Electrician and former house flippers. It just going to raise the cost of employeeing scientists and engineerings who always have lower unemployment rates.
Paul Krugman and Brad DeLong have shown evidence proving this wrong. There are no, repeat no, sectors of the economy currently experiencing wage increases
But you see,
The whole credit thing aside, what you are saying may not seem like crowding out in the here and now because resources are idle. But those idle resources will not stay idle for long and they are idle for a reason and lack of demand has nothing to do with it. That lack of demand is a side-effect of something else. Many changes in patterns of production are always happening and those resources will be engaged. Perhaps not today but perhaps tomorrow.
Don’t try explaining the temporal component of capital to a keynesiac. They are programmed against it like a cultist against skeptics. Their dogma is “maximum economic activity ASAP.”
“the crowding out argument doesn’t make a distinction between types of spending.”
Either you’re misunderstanding, or playing games. The crowding out argument that people here make DOES make the necessary distinction between public and private spending. In fact, that is the whole point of the argument. That’s why it is nonsensical to compare it to private spending crowding out private spending. The incentives, and therefore the kinds of spending on average between private and public, are quite different.
Russ is right. Crowding out is ONLY about the choice of spending, and has nothing to do with where the money previously came from. $100 borrowed from the frac res bank is just as fungible as $100 out of the cookie jar. You have the same choices for both $100′s, and what you didn’t choose, is what you didn’t spend it on. The reuse and creation of money is completely irrelevant to that argument, since you must still choose how to spend it, no matter where it came from.
Why must public spending come at the expense of private spending, but ‘other’ private spending must not?
It does, but when capital flows to A it is because B generates a lower rate of return. A is more productive than B.
Here’s a cheap shot that’s totally deserved.
I guess since the price of deleting comments you don’t like on your blog is nearly zero… you SHOULD do it. Right Brad?
Delong’s on board with that!!
Isn’t Brad DeLong’s argument really to expand the collective? DeLong is the quintessential collectivist and basically any and all arguments DeLong makes circle back to the expansion of the collective.
Dat’s Delong and da short of it.
When I’m thinking of investing, I assume that the current market price of an item takes into account all positive and negative information unless I believe I have information that the market doesn’t. In that case, I trade on that information. Even then I am skeptical as to my own greater wisdom — there are smart people in every market, so mispricings are not the norm.
That said, I’ve made the short term choice to rent instead of buying.
Brad DeLong’s entire blog reads like an attempt to mold fundamental principles to an ideology instead of seeing where the fundamentals lead us. If I recall correctly he thinks we’ll all be fine if the government starts taxing us well over 50% (his take on Laffer curve optimization). That strikes me as so far from reality as to me a purely emotional anchor.
I read his blog for a while, but I just found it absurd most of the time.
I’m confused by this talk of government “production”. What does government produce?
So far, I’ve seen it produce bridges to nowhere, a national rail system which is a national drain, Ponzi schemes, corporate welfare, farm welfare, welfare welfare, and an intricate maze of Czars. Then there’s the ever growing army of petty bureaucrats whose chief purpose is to pour sand in the gears of anyone daring or stupid enough to be productive.
Although!….to the government’s credit, I’ve noticed that recently it is producing much better, easier to navigate websites so that we poor shlubs can more easily find the correct bureaucrat to pour sand in our gears.
Other than those super valuable items, what valuable production flows from government?
out of the top of my mind:
the reversal of the course of the chicago river (done by army corps of engineers) (responsible for the economic success of chicago)
the hoover dam
the golden gate bridge
the brooklyn bridge
the erie canal (responsible for the economic success of NYC)
Wilson and Douglas Dams (built by the TVA)
those are some of the things government produces. i guess you would say they are pretty trivial.
again, government spending CAN BE wasteful. it´s even true that is often is. but that DOES NOT MEAN IT CAN’T BE PRODUCTIVE. it sometimes is. when it´s done right it can be incredibly productive. even to the point of helpinbg create two of the richest cities in the history of mankind
oh i almost forgot. the government provided the funding for research that lead to the development of the internet.
yeah, that didn´t turn out to be productive at all…..
Some formerly at the Xerox corporation would take issue with that story.
Two things, JCE:
First of all you assume that no bridges, no damns, no canals, no roads and no internet would be built without government. Why? If these projects are so wildly successful, that means that they were wildly in demand and would have yielded a high rate of return on investment. Why then the assumption that no private capital would have sought out such massive alpha? That is the constant Keynesian assumption.
For the sake of argument, let’s say the projects you mention are not wasteful and the added benefit at least covered the cost (and we won’t mention that it is inherently unfair and abusive to force people who have no need of those projects to pay for them anyway). Your argument reminds me of the guy who won $1,000 in the lottery….after spending $15,000 on lottery tickets. He claims the lottery is worth playing because he won a whopping $1,000. No mention of how much that $1,000 cost him.
While I accept the argument that government CAN be productive, I don’t accept that it IS productive. The number of wasteful projects it undertakes exceeds the number of non-wasteful projects by a wide margin. It can do that because there are no direct consequences to the decision makers in government when the project is found to be wasteful and there are often direct positive consequences for decision makers in wasting resources (that’s why rent seekers are so successful). The ratio of wasteful spending to non-wasteful spending, along with the amount wasted and the level of success of successful projects informs us of the probability of government wasting the next dollar.
Since government engages in far more negative NPV projects than zero or positive NPV projects It is reasonable for us to forecast that the next dollar spent by government will be wasted.
Why on earth would you want capital committed to this hot mess?
“First of all you assume that no bridges, no damns, no canals, no roads and no internet would be built without government. Why? If these projects are so wildly successful, that means that they were wildly in demand and would have yielded a high rate of return on investment. Why then the assumption that no private capital would have sought out such massive alpha? That is the constant Keynesian assumption.”
I´d argue two things:
1. That is not a keynesian assumption. that´s a public economics assumption derived from the well known problems of collective action, public goods etc
2. i didn´t assume those wouldn´t be built without government. i showed actual examples of projects that WERE built by government.
the erie canal story helps prove my point. there was private demand for the project, ample demand. but the private attempts to build it failed. when the state of NY intervened it built the canal succesfully
again, i agree that “government engages in far more negative NPV projects than zero or positive NPV projects”. but the fact that it engages in some positive NVP projects tells that they aren´t inherently out of its reach.
My apologies, JCE, it’s not “constant”.
I can’t comment on the erie canal because I know literally nothing about it. I’ll make the assumption that you’re right.
The success that is the erie canal still doesn’t change anything. I already understand that, on occasion, government can stumble into positive NPV projects. You already agree that wasteful projects outnumber the non-wasteful projects by a pretty wide margin. Based on this, we can only conclude that government projects are negative expectancy.
Why would we allocate capital to negative expectancy projects?
It produces economic destruction.
Otherwise known as “negative expectancy”.
I don’t understand why people who would never commit their own capital to a money losing proposition somehow magically believe that when it’s government “this time it will be different”.
Well, I do.
They’re not committing their own capital. They’re committing mine.
You sneak an awful lot of assumptions in with this sentence: “The cost of government spending is foregone private spending“
And reviewing the comments now, I see I’m not the only one to point this out. Excellent.
No you are not the only person who does not understand opportunity costs.
…but apparently you are one of the incredibly large number of commenters here that doesn´t understand how a credit economy works
that’s you in the mirror.
Talk about assumptions….
Specifically?
When you make accusations like that as if opportunity costs invalidates my point, it only demonstrates that I know considerably more about opportunity costs than you do.
And in getting back to our exchange in that other thread, I present Brad’s point, based on the wrong-headed demand-based analysis of Keynesian Econ, as an example of using a truthy concept to make flawed arguments that ignore those complex and messy subtleties that one sees from a proper foundation based on market process.
Never mind whether Brad’s argument makes sense from the narrowness of Keynesian thinking. That’s not the point. Idle resources are not in a vacuum and are idle for a reason. There’s a lot happening there that propping demand through cheap borrowing simply cannot account for. This line of thinking never goes into WHY those resources. Therein lies the truth. Just because a car has gas in it doesn’t mean it should be driven for its own sake. It’s there waiting for something useful and interfering with that just because the gas can be used misses that “needlessly complex” and messy side of economics. Same concept.
What are your assumptions?
I believe Delong makes a more fundamental error of logic.
The problem with using prices to decide what government does is that it does so much for ‘free;’ taxes and debt spending are only partly connected to its services. If the price of its debt falls, it has very little relation to how much spending it should do.
Put it this way. If government charged for its services according to its activity based cost, very many of its services would go unused. It is the largest entity in the world producing services and products no one wants at the proper price point. It is very likely that many government services would not be salable at half the cost.
So if the cost of debt goes down, how does that in any way mean the economy should be filled with more services no one wants? Sounds like another ditch digging argument to me. Go for it Delong. Maybe when you’re digging, you can spare us the talking.
“There is no worse tyranny than to force a man to pay for what he does not want merely because you think it would be good for him.”
— from Professor de la Paz’s speech to Congress. ‘The Moon Is A Harsh Mistress’ by Robert A. Heinlein
You have to remember one of DeLong’s favorite lines: government spending is as good as anyone else’s spending. He literally sees no difference between the two as long as there is a single idle resource, somewhere.
THERE ISN´T!!!!
We understand your problem now, but we can’t help.
JCE, I had no idea you’re a comedian!
Oh yes there is.
And you actually concede that point with your response on Kling’s post at EconLog in that link I provided below.
As Kling states, permanent employment shifts need sustainable patterns of trade…and not just lighting a fire where it can’t thrive (in a manner of speaking) where it can’t sustain itself. Knowing where people OUGHT to be employed takes knowledge that DC doesn’t have.
So, by asking Kling to suppose, for the sake of argument, that DC actually COULD do this, you not only present a worthless thought experiment that rests on an impossibility…like in my response to “suppose that people could fly…” but you also acknowledge that the spending is not the same.
To a Keynesian, there may be no difference, but in the real world, there indeed is a difference.
Delong seems to have adopted the conehead theory of economics, that consuming mass quantities will somehow result in prosperity.
Another name for this brand of ‘economics’ is Keynesian.
Professor please. Reducing keynesian economics to the ridiculuous cartoon of spending=prosperity is a grossly simplistic reading of keynes.
you do great damage to knowledge and learning to ridicule deep, prolific thinkers like that.
adam smith was much more than the invisible hand
descartes was much more than ‘i think therefore i am’
schumpeter was much more than creative destruction
hayek was much more than laissez faire
don´t reduce these people to slogans
If time were not a scarce resource, only then would it be sensible to talk about solely the costs of slogans (signals).
…. In the words of George Orwell:
“By using stale metaphors, similes, and idioms, you save much mental effort, at the cost of leaving your meaning vague, not only for your reader but for yourself.
… People who write in this manner usually have a general emotional meaning — they dislike one thing and want to express solidarity with another — but they are not interested in the detail of what they are saying.”
– George Orwell. Politics and the english language
Is it partial equilibrium or general equilibrium? If the interest rate is 0%, while one may wish to borrow more, who will supply the funds that one can borrow from. Assuming that supply is forthcoming is partial equilibrium in a world that is more of a general equilibrium type. Now, what if supply is in fact forthcoming at 0% interest? Then, the individual supplying the funds is driven by other factors besides the interest rate, such as safety of principal.
“Yes, to the extent that mortgage rates drop, people can afford to buy bigger and more expensive houses.
And they should do so.”
Really? That was a terrific success, right?
Brad’s example is terrible; he offers no logic to back it up, just more analogies that don’t substantiate his point. Why should people buy more expensive houses when interest rates are low? Would they not be better off buying a house that meets their needs, and using the extra money to buy other things they want, instead of tying all their money up in a house that is bigger than what they need?
What happens when interest rates rise, possibly all of a sudden?
Arnold Kling makes a great on this that gets to the heart of the problem:
“My problem with fiscal stimulus is that I believe we need permanent adjustment to new sustainable patterns of trade, not temporary moves. I think that if you want to eliminate unemployment in a meaningful way, you have to know something about where people ought to be employed, and Washington does not have that information.”
http://econlog.econlib.org/archives/2011/03/crowding_out_a.html
Yes, to the extent that mortgage rates drop, people can afford to buy bigger and more expensive houses.
And they should do so.
When we decided to move up, my wife’s main criteria was a large yard.
We found a suitable property.
Mortgage rates have dropped, as has the price on our property.
Moving is a big hassle. The only reason that would justify a move now would be a suitable property closer to where my wife practices veterinary medicine, but the prices in that area are much higher.
Brad’s advice might be good for someone, but it make no sense for us.
A private company may have a portfolio of possible projects with varying forecast rates of return.
As the interest rate drops more projects become economically attractive.
That’s great, but it doesn’t justify government spending nor buying bigger houses as this type of spending isn’t really driven by future cash flows.
A person may buy a treasury on the idea that the US government is about to cut spending and put itself in a better position to repay its debts.
Russ refers to “the Keynesian idea that when there is excess capacity, government spending is a free lunch–-there is no foregone private output . . . .” Now, this Keynesian idea seems awfully plausible. When there are unemployed workers and unemployed resources–”involuntarily unemployed,” in some sense–then if the government could commandeer just those workers to work with just those resources in producing something of positive value, even if the value were slight, that would improve the situation. Of course, increased government spending, if improperly targeted, *might* draw workers and resources away from the private production in which they were going to be employed, into less productive governmental production, while leaving the unemployed workers and resources unemployed. So beneficial government spending will have to be properly targeted, at the unemployed rather than at the already employed. Perhaps DeLong is insufficiently sensitive to this point; he seems to be thinking, crudely, of undifferentiated “government spending.”
Russ continues the above quotation: “. . . or if there is [foregone private output], the lower interest rate says there’s less foregone private output.” This seems a definite error in the Keynesian thinking (Roberts’ version): the interest rate has nothing to do with the amount of foregone private output.
How does the government decide where spending should go?
Can you say “influence”?
If lower interest rates should lead to more borrowing, then one could assume that the government should cut taxes. This makes just as much sense as more spending – however, I am sure that Mr. Delong would not like to see this.
Indeed! (On both counts.)
Oh no no no. There’s only one way to grow debt–spending, and one way to cut debt–taxes.
DeLong writes that “to the extent that mortgage rates drop, people can afford to buy bigger and more expensive houses.” Shouldn’t this be: “to the extent that *housing prices* drop, people can afford to buy bigger and better houses”?
Suppose I am saving for my retirement. If interest rates are high I can get by with less saving, since compounded interest will swell my retirement savings. If interest rates are low I must save more in order to have enough on which to retire. When I am being paid more for saving, I rationally do less of it.
Real or artificially low interest rates?
In a conference on house financing reform Alan Greenspan recently mentioned that before doing anything he would like to know better what would be the interest rates for house financing without any government intervention… that is as blind as they are flying
When later I asked him “would you not like to know what the interest on public debt would be if the banks were required to have the same capital when lending to the government than when lending to a small business?” He answered “it is not precisely the same thing but it lies in the same area of interest”
In a rational utility based model, your optimal number of shirts will always go up when the price goes down. Your right, that the change in the number of new shirts that is optimal will decrase rather rapidly with linear price reductions, but it doesn’t change the underlying margin.
Think if shirts cost $0 (including cost of organization and storage), the only logical thing to do would be to have an infinite number of shirts.
BUT, there are still a few decent arguments to use against Brad.
First, just because the price of government spending goes down, doesn’t mean that spending has to be a good idea, just a less crappy idea.
In our shirt metaphor, you could still be above the optimal number of shirts, an raising the optimal number doesn’t necessarily put you over your current number of shirts.
Second, this isn’t a one dimensional margin, but at least a two dimensional one. With cheaper government debt, you can either reduce taxes or increase spending. Rational choice models would have to leave spending alone until the marginal gains are equal between the two.
Think if shirts cost $0 (including cost of organization and storage), the only logical thing to do would be to have an infinite number of shirts.
Even free shirts aren’t cost free.
Where does one store an infinite number of shirts?
In a hyper-dimensional closet.
Does there have to be disagreement here? It is true that, given a few basic conditions about opportunities for spending and investment, we should take on more debt when interest rates are low than we should when interest rates are high. It is also true that we’ve been borrowing way, way, way too much money. So if lowering interest rates mean that we’re now down to merely borrowing way too much money, that doesn’t mean we should borrow even more, that just means we have slightly more time to reduce our borrowing before fiscal disaster is economically unavoidable. (note: fiscal disaster is already/still politically unavoidable)
It’s also important to realize that the current interest rates are not the result of voluntary exchange; i.e. individuals are not forgoing spending at their own expense in order to buy US bonds. The vast majority of these bonds are being purchased by the Federal Reserve via QE2. When the Fed stops purchasing the government’s debt is such large quantities, we will be able to hear what the market has to say about the value of government debt.
I was under the impression that interest rates are low because the Fed. is in the open market buying US treasuries. If the US issues more treasuries, either interest rates will rise or the Fed will end up with more securities on its balance sheet.
I really don’t see how one can argue against DeLong. It’s standard econ 101, right? After all, didn’t we just have that situation with nice low mortgage rates telling us we wanted a bunch of new housing? The worked out pretty nicely for us, didn’t it?
The fact that DeLong is arguing that low mortgage rates mean it’s always a brilliant idea to buy a big new house proves two things:
1. Keynesianism is built on a rock-solid foundation of ignoring even the most recent history.
2. There is no conclusion so obviously wrong that a Keynesian will not make it.
Russ,
“The cost of government spending is foregone private spending” only to be followed by this later on: “Brad is implicitly arguing that another bridge or road or bigger payments to farmers or expanding the US military doesn’t mean less of something else”
Again, this need not be the case as I explained in a previous post. The degree to which government spending reduces foregone private spending need not be one-to-one (complete crowding out).
Normally, we estimate that there is partial crowding out [that is, the interest elasticity of money is neither perfectly inelastic (complete crowding out) nor perfectly elastic (no crowding out)] in the shortrun, but most old-school monetarists who actually knew macro would never deny some degree of expansionary fiscal policy if you could squeeze out a serious confession.
Only at full employment is this a valid argument, but we’re nowhere near it. And, in fact, the liquidity trap conditions we find ourselves in today (ooops…so much for the policy ineffectiveness proposition!) and the large Okun gap means that fiscal policy can be expansionary with little or no crowding out.
So Russ, why do you just assume that $X of government spending displaces (crowds out) and equal amount of private spending?
If you’re assuming neither full employment nor a perfectly inelastic liquidity preference function, then what model is informing your view? Are you using an accounting identity?
–Pingry
Dear Brad:
Since government owns printing presses, lots of enforcement mechanisms, and a de facto theoretical infinite supply of revenue, government basically sets interest rates, especially given powers granted under the 1913 Federal Reserve Act.
http://www.federalreserve.gov/aboutthefed/fract.htm
And later expanded.
A lot.
So basically your argument is: interest rates are low because interest rates set by government are low, and as long as government keeps borrowing rates low, they will stay low, so we should borrow more.
In other news, Allied bombers continued their relentless assault on Europe and Japan, given the almost century-long broken window boom, and are about to re-expand into Libya….
Government (Actually, the Fed) doesn’t “set” interest rates. They target them for very technical reasons and they must undertake defensive open open-market positions to stay close to the target.
How is this possible? Because of price rigidity. Of course, in the longrun, no central bank/government can “set” or target interest rates because of the natural rate of interest set forth by Wicksell prevails.
–Pingry
Bullshit they don’t set rates.
They set target Fed Funds, which are Federal Funds rates, which are the overnight lending rates for Federal Reserve member banks; the set the Fed Window Discount rate, which is the rate at which Fed member banks can borrow from the Fed; they set spreads, via open market operations, at short, mid, and long end curve intervals.
Target rates are very specific, and only 1 lender of last resort is capable of this targeting, due to depth of capital.
Care to rephrase, dipshit?
Clearly you have no idea what it means to target interest rates, dipshit
–Pingry
You are arguing semantics. The Fed does not peg rates (the way FDR arbitrarily pegged gold prices), but the Fed most definitely does set rate targets, and for the short end of the curve, they are very successful. For longer durations, the Fed has had less success; however, they have recently enlisted help from a small group of investors known as China.
Until recently, the voracious Chinese appetite for US Treasuries has succeeded in keeping long term rates low. Because of our precarious debt situation, they (and everyone else) are more reluctant to take on additional US obligations, making DeLong’s assertion that we should borrow even more because rates are low even less coherent. The act of creating additional borrowing would likely drive rates up, defeating this purpose.
DeLong (and apparently you) fails to understand that Keynesian stimulus has diminishing returns, and at some point it fails for countries approaching critical mass debt levels (e.g. us).
On DeLong v. Cowen:
I don’t disagree with DeLong when he says that “we should make more government debt–pull spending forward from the future into the present and push taxes back from the present into the future.”
That, of course, is a normative preference which would work given what I wrote in my earlier post.
Otherwise, when DeLong says “Right now with the decline in interest rates on government debt the market is telling us that government debt is more valuable than it was last week,” only to be followed by Cowen’s “a low rate of interest on Treasury securities indicates a high chance that the investors will be paid back,” they’re pretty much saying the same thing.
I agree with Tyler when he says “It [low rate on Treasuries] is not a market signal that the government output should be produced.” because the market doesn’t signal normative preferences like DeLong says, but it does signal that the government output could be produced, and as pointed out numerous times, it could be done with little or no crowding out given the current state of the economy.
–Pingry
You probably should disagree with DeWrong, as this is simply kicking the fiscal nuke down the road.
Which is a proven economic failure:
http://www.coyoteblog.com/coyote_blog/2010/06/stimulus-was-a-clunker.html
it could be done with little or no crowding out given the current state of the economy.
And what about when the debt comes due tomorrow? Weirdly, markets are forward looking.
If there were some golden opportunity that the U.S. could take advantage of by borrowing more, then I’d say, go ahead. And these types of opportunities have come up in U.S. history – the Louisiana Purchase and Seward’s “Folly” come immediately to mind. (Maybe Russia is looking for someone to unload Siberia on.) But short of that, the U.S. should take advantage of lower interest rates by paying off debt, not accumulating more debt, in the same way that someone who buys a house and gets a better interest rate than he expected could use the savings to pay off his student loans or his car.
Hi Brad Delong! I hope you get this, cause I really need your advice. I went to the store today to buy a cell phone, because my old one is broken. When I arrived at the store, I noticed they’re having a huge sale on Hi Def TV’s, TODAY ONLY! The thing is, I can’t afford to get a TV AND a cell phone, and I already bought a TV last year. I don’t even like TV that much, and I certainly don’t need a 2nd one. Besides, I really need a cell phone. The only thing holding me back is that I remember your claim that it’s foolish not to buy something when the price has fallen. This is quite a pickle I’m in. Any guidance would be greatly appreciated.
Confused.
You are comparing government to a consumer when really it is more like a business. And lower T-rates makes various government projects more “profitable” as measured in value to their “clients,” the people. I.e., a business has a project that the ROI is 10%. If interest rates drop below 10% and all the way down to 5%, that’s worth doing now because of the lower rates. So DeLong WOULD be right if the government weren’t doing these projects that are more like borrowing money and building … “sand castles at low tide” or more in the way of buying a bigger house – having fun with other people’s money.