Thursday, June 07, 2012

Uncertainty and Credibility: Especially Weak Excuses For Letting Other People Continue to Suffer

-- Posted by Neil H. Buchanan

In recent weeks, my posts here on Dorf on Law have largely been devoted to discussing why the major governments of the world have refused to engage in a classic Keynesian response to the ongoing economic disaster. Millions of people continue to suffer, with many out of work for years, yet governments here and abroad have taken the most perverse actions possible, throwing even more people out of work (both directly, by laying off government employees, and indirectly, through multiplier effects), with politicians arguing that this fiscal "responsibility" will help us return to prosperity any day now.

The failure of the agenda that the Austerions are pushing, so-called expansionary austerity, is plain to see. Nevertheless, the Austerions are undaunted, claiming that their theory was never really given a fair test. In my discussion of that particularly bizarre claim, I wrote: "We can expect some Austerions now to claim that the problem was that people were worried that austerity policies might be abandoned."

A leading Austerion, John Taylor of Stanford's economics department, wrote last week: "In my view, unpredictable economic policy—massive fiscal 'stimulus' and ballooning debt, the Federal Reserve's quantitative easing with multiyear near-zero interest rates, and regulatory uncertainty due to ObamaCare and the Dodd-Frank financial reforms—is the main cause of persistent high unemployment and our feeble recovery from the recession. A reform strategy built on more predictable, rules-based fiscal, monetary and regulatory policies will help restore economic prosperity."

This, of course, is actually less coherent than the argument that I predicted that we would soon hear. Taylor cannot admit that his preferred policies have actually been in effect for the past few years, so he claims that the policies favored by liberals and Keynesians are to blame for the continuing problems in the economy. But, it is not exactly those policies that are at fault, he says, but rather the uncertainty caused by enacting those policies in the first place. The problem is apparently that businesses are uncertain about what might come next. To address this, Taylor wants the government to adopt specific rules that everyone knows it will follow.

But why are his rules better than any others? Standard Keynesian policies (because they are standard) are well-known and predictable, too. Any business operating under a government known to adopt Keynesian policies would know that there would be fiscal stimulus in the current circumstances, and that the stimulus would end when the economy recovered. That is what textbook Keynesian economics means.

As to the uncertainties supposedly associated with "the Federal Reserve's quantitative easing with multiyear near-zero interest rates," how much more certain could we be? The Fed has announced that it will hold to its zero-rate policy for at least another two years. and it has announced its criteria for changing that policy. Moreover, the "regulatory uncertainty due to ObamaCare and the Dodd-Frank financial reforms" is easily fixed: Stop trying to repeal those laws, and allow the regulations to be written and enforced, without having the Republican Party do everything within its power to weaken (and add wiggle room -- that is, uncertainty) to the rules.

If any of this sounds familiar, it should. Almost two years ago, the right's argument for extending the Bush tax cuts was that doing so would create "certainty" for businesses. As I argued here on Dorf on Law at the time, any action at all on the Bush tax cuts would have provided certainty. And the continuing uncertainty at one level of remove -- from not knowing whether those policies will ever be changed -- is a necessary part of dealing with human beings. Even when humans put in place completely predictable policies, after all, those same humans can later dismantle those policies.

This means that the right's certainty trope is, again, a Trojan horse. They complain that liberal policies frighten and confuse businesses, because those policies are so unpredictable. We could make those policies as predictable as we might like, but it is difficult to imagine that the Austerions would suddenly think that the policies were a good idea.

A similar logical problem can be seen when policy makers invoke "credibility" as their reason for sticking by their decisions. Fed Chairman Ben Bernanke recently argued against deliberately raising the Fed's inflation target (as a temporary measure, to allow the real economy to recover), saying that this would undermine the Fed's "hard-won credibility." If one's definition of credibility is "unwillingness to change an inflation target," then of course this is a tautology. But credibility can mean a lot more than that. For example, if the Fed were able to announce that it would temporarily allow inflation to rise, and it then succeeded in increasing inflation temporarily, would its future announcements not become more credible? That is, if the Fed's current credibility is based on the idea that it will never allow inflation to go up, but it could instead show that it can respond to economic fluctuations by adjusting policy effectively, then one would think that respect for the Fed would rise markedly.

One could, of course, argue that the Fed is not capable of pulling that off. I think it could, but maybe I am wrong about that. If I am wrong, however, the Fed would still have gained credibility of a different sort. They are currently credible in the sense that everyone knows that they are willing to ignore half of their legislative mandate (reducing unemployment) in favor of the other half (minimizing inflation). If they announced that they were taking both halves seriously, then they would be viewed as credibly obeying the law.

Bernanke's argument, in any case, is not that they cannot do what has been suggested, but that doing so would undermine the Fed's reputation in the public's mind. And it is the content of that reputation that really matters to Bernanke. He is not worried about his institution being viewed as competent. He wants it to be viewed as completely hostile to inflation above 2% (the current target).

It is possible to enact fiscal and regulatory policies, and for the Fed to credibly change its monetary policies, in ways that would expand the economy. Hiding being "certainty," "credibility," or any other excuses allows the defenders of failed policies to change the subject from the failure of those policies. Meanwhile, people continue to suffer.

12 comments:

The Dismal Political Economist said...

I think in general you are correct but the one area where Taylor and others are correct is tax policy.

The temporary nature of the tax code is extremely destructive. In fact it is more destructive than high taxes. A business can thrive in a high tax environment (particularly when those taxes pay for things critical to business success like education, training and infrastructure) but it is difficult to thrive in a state of tax uncertainty.

Everyone wants business to invest more, but at this time no one has any idea what the tax laws will be in 2013, much less for the long term. Until policy makers settle on a tax regime and make it permanent this uncertainty will be an economy killer.

Neil H. Buchanan said...

I completely agree with TDPE about the destructiveness of the current flux in tax policy. This does not, however support Taylor's position. As TDPE notes, this uncertainty is worse than high taxes. Therefore, we could improve matters by enacting high, certain rates. That's not what Taylor et al. are saying. My position is that, if you think uncertainty is really the problem, then you should be neutral about the content of the certain policies, or you should be honest about your real reasons for supporting specific policies. Being "against uncertainty" doesn't get you to the Republican (or Democratic) position.

Michael C. Dorf said...

Indeed, someone who thinks uncertainty is the problem should be arguing for various procedural mechanisms that encourage "stickiness" with respect to economic policy. Arguably, we HAVE some such mechanisms, because of the de facto super-majority requirements for legislation by Congress. But I think that stickiness itself has a seeming conservative bias. It's true that you can describe a commitment to Keynesian stimulus and low interest rates in bad times, coupled with surpluses and tight money in good times, as "sticky" at the meta-policy level, but it looks like flux at the snapshot level: Sometimes government runs surpluses and sometimes deficits; sometimes government supports easy credit and other times tight credit. Thus, Austerions/Austrians--who believe in low taxes, low spending, and no monetary policy in all times--can CLAIM that the policies they favor are stickier, even though, with respect to what should count, they aren't.

The Dismal Political Economist said...

I agree that having a high but fixed tax regime is not what Taylor is saying. But being for certainty does not mean being for 'neutrality' with respect to the level of taxes.

What it does mean is that the provisions of the tax code should be greatly simplified, and then the appropriate rates applied to generate the correct fiscal policy.

This does not rule out a highly progressive tax rate that produces fluctuations in revenue. In fact, a highly progressive rate structure is required for a fixed system.

The more progressive the tax rate the better for fiscal stimulus/stability as revenues would increase disproportionately as the economy increased, reducing the deficit and fall disproportionately as the economy weakened, providing automatic stimulus. The would meet the criteria that Michael has cited with respect to 'stickiness'. The structure would be fixed, the economic impact would vary accordingly and the system would not have to be changed as much as it does today.

It is much less critical that monetary policy be 'sticky'. We can anticipate and plan for fluctuating monetary policy because it is administered by an appointed body, not an elected one. Using hedges and fixed rate instruments a rational investor or business can rather easily insulate themselves from uncertainty in monetary policy. That is not possible with tax policy.

Unfortunately the movement towards flatter tax brackets is a defeat for fiscal policy and for certainty in the tax structure and tax rates. And it means more rather than less intervention as Congress must change rates to meet changing economic conditions. A flatter tax system just results in more uncertainty.

Currently the U. S. is stuck with a huge amount of temporary tax measures, so the mechanism for changing the tax regime must be flexible. Until the system is defined for the long term it is largely self-defeating. Temporary provisions require 'un-stickiness' in the process, which produces more temporary measures.

The failure to achieve a fixed, fair and relatively simple tax system is a bi-partisan failure. Again Neil is correct, being against uncertainty and developing tax reform does not get anyone to either the Democratic or Republican position.

Neil H. Buchanan said...

Thanks to Mike for his comment, and TDPE for his follow-up. I completely agree with his analysis, as I understand it.

Shak Olreal said...

It is much less crucial that financial plan be 'sticky'. We can predict and plan for varying financial plan because it is applied by an hired body, not an chosen one. Using trees and set rate equipment a logical buyer or business can rather easily protect themselves from concern in financial plan. That is not possible with tax plan.

Unfortunately the activity towards slimmer tax supports is a beat for financial plan and for guarantee in the tax framework and tax prices. And it means more rather than less treatment as The legislature must modify prices to satisfy modifying financial circumstances. A slimmer tax system just results in more concern.office 2010 key
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