Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Friday, February 5, 2010

Robert Reich on the Necessity of Obamanomics

For those of us who are "either not thinking hard enough or a Republican running for office," former Secretary of Labor, Robert B. Reich, has an economics lesson for us; see here.

I had a good chuckle over this:

You don't have to be an orthodox Keynesian to understand that as long as the private sector is deleveraging, the public sector has to borrow and spend to keep the economy moving forward.

You don't? Holy cow...this is essentially the defining characteristic of "orthodox" Keynesianism!

Look, maybe a case can be made for a deficit-financed government spending program. But surely, in making the case, we deserve better than this?

Do we not need to know first why the private sector seems reluctant to spend? If we have just lived through a period of "excess,'' might it not be prudent to cut back on spending? Or is it the role of government to replace private excess with public excess?

The collapse in private spending is primarily in investment. Why are businesses holding back? I have heard business people say that they are afraid to invest right now because they are so uncertain about the future course of government policy. Given this uncertainty, it is probably prudent to withhold investment, until it becomes clear where it may be most profitably allocated. And if this is a reason for depressed investment activity, this is an example of government failure, not market failure.

Or is it, as the "spend your way to prosperity" crowd would have us believe, simply a matter of "irrational" psychology? The private sector is evidently afraid to spend, for no good reason at all. This calls for bold government action. The government evidently knows that the fundamentals have not changed. Just charge forward and spend...and all will be well.

O.K., well here is a question: Spend where? If what we are experiencing is really just a psychologically driven "negative aggregate demand shock" -- the "demand side hole" suggested by Reich -- then how to explain the following data?

I presume that Reich would recommend targeting government money to plastics, motor vehicle parts, furniture, printing, and textile mills. The presumption must be that these sectors are declining for no good reason at all. I'm not sure how he would explain the expansion in semiconductors, communications equipment, computers, electricity, and oil and gas. How did these sectors miss being dumped into the great demand-side hole?


  1. David,

    Thanks for posting this. It gives me the following in:

    I'm beginning some research on the corporate response to booms and busts, and I've been gathering papers regarding investment and capital constraints and whatnot. Are there any seminal articles that you might suggest in this field? Essentially, I want to explain why some firms expand and others contract. Unfortunately, business cycle research is new to me (and it was not my advisor's field), so I'm reaching out to anyone who knows it better than me.

  2. The classic (modern) paper is the JPE (1983) piece by Long and Plosser "Real Business Cycles." They are explicit about sectoral interlinkages.

    I might also recommend the following:
    "Intermediate Inputs and Sectoral Comovement in the Business Cycle" (with Jack Praschnik). Journal of Monetary Economics 40, no. 3 (December 1997): 573-595.

    It would be interesting to embed within these environments the notion of a "news" shock (to replace or augment the regular TFP shock). See:
    Jaimovich, Nir and Sergio Rebelo. Forthcoming. Can News about the Future Drive the Business Cycle?. American Economic Review.

    I would be leery about the proposition that firms are debt-constrained in their investment choices. I recall Fumio Hayashi and Ed Prescott arguing that Japanese firms in the 1990s were flush with cash. V.V. Chari argues that the same is true for U.S. firms today.

    Firms are retaining earnings and building up cash. They are reluctant to spend (invest) not because their are liquidity constrained, but because the expected return to capital investment is low. Why these expectations are so negative is worthy of exploration.

  3. "Why these expectations are so negative is worthy of exploration."

    Because their customers are declaring bankruptcy at an increasing pace? Maybe the whole consumer/service based economy was a bad idea.

  4. Pointbite: you need to think more deeply than this. The question is why are bankruptcies on the rise? What is the *fundamental* shock that triggered these events? Is it just psychological? Or did something fundamental change?

  5. If you're asking why companies are not investing, I think my answer is probably not dis-similar to what you would hear in many boardrooms. They aren't investing because they don't need more capacity.

    Why demand isn't growing is a different question. I align myself to the "fundamental" camp. I have believed for a while that we just experienced a multi decade consumption binge funded with easy money and consumer credit that must be reversed (multi decade savings binge) for something ressembling stability to return. How can credit grow faster than income indefinitely? It makes no sense. Many businesses and people employed in them will find themselves illevant in the near future. I just hope they have incompetent lobbyists so the money can be better spent elsewhere. I would rather make a top 10 list of diseases and spend a billion dollars to cure one disease every year... or we could just give it to GM.

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  8. David,

    Thanks for the suggestions. I'm a recovering empirical corporate finance researcher, so I appreciate the help.

    I would like to posit the following possibility regarding the current lack of capital investment. The malinvestments that were made still plague the system. Due to the variety of governmental support, the TARP programs namely, there hasn't been the appropriate "working out" stage. The bad assets are still on banks' balance sheets.

    Then, you've got boatloads of liquidity in the financial sector. Businesses have finished burning through their old inventory. They will have to start buying now. There are strong inflationary pressures in the offing.

    This was also an international bust, addressed in much the same way in the OECD countries. That means that the types of risk in the U.S. may be playing out in other countries. We may have started seeing that already.

    So, put all these risks together, plus the action in Washington vis-a-vis health care, and the various other shenanigans that typically go on there, and you've got an environment fraught with peril. I'm not the least bit surprised that few companies want to move forward with an investment program. The economy has the potential to change so quickly that what appears to be profitable now may be a terrible idea in a few months.

    P.S. Those two posts above (mishikraz) were from me. I didn't realize I was signed in to my wife's account.

  9. David,

    This is off-topic, but since you are at the Fed, maybe you can help.

    How does $1 trillion get drained from the financial system? I understand the mechanisms by which the Fed wants to get banks to keep the money in reserve, like raising interest rates on reserve holdings. What I don't understand is that the accounting entries still exist. It's not like destroying old bank notes, is it?

    I think I am missing a crucial piece of this puzzle, so if you could illuminate the issue, I'd be grateful.

  10. Prof J,

    Not sure if I understand your question entirely. But short answer is yes, destroying accounting entries is just like destroying (or removing from circulation) old bank notes.

    We can discuss more if you want by email:

  11. Thank you for posting that most interesting bar chart.

    I am curious to know who are the cash flush companies that are hesitating to invest. Are they in the shrinking sectors, or the expanding sectors, or are they scattered throughout the economy?

    What is driving the uncertainty or the doubts? Knowledge of how economies tend to recover slowly and painfully from financial sector crisis-driven recessions? Or a lack of confidence in the current political leadership and concern for the apparent inability of Americans to renegotiate social contracts?

    Is the apparent growing polarization of American society decreasing business confidence?

  12. Businesses aren't investing because of 2 reasons:
    1) Can't get financing from overlevered banks
    2) Consumer demand is shot

    Neither of these really has much to do with the govt. (Well, not really, you could strain to make connections)

    Govt spending should be counter-cyclical in order to smooth out bumps in the business cycle. Here is a good explanation