Anopinion 4

Reading the first few paragraphs of Last War Brain by Noah Smith, I thought I would strongly disagree with his post and decided to write an attempted rebuttal. I find that I agree almost 100% and can mainly complain about what I assert is a bit of bait and switch. As always I advise readers to just click the link. Noah is a much better writer than I am (low bar) so my effort to summarize and explain might best be skipped (skip to ***)

Noah argues that liberals have overlearned two lessons of the noughties and teens: The lessons are don’t invade Iraq, and don’t impose austerity when the economy is depressed. Now he argues that some people are incorrectly assuming that Russia v Ukraine is like Bush V Saddam and that the macroeconomic policy mistake to fear is insufficient stimulus as it was 2008-2015 (at the earliest).

I agree entirely about Urkaine. It is silly to act as if US threats of economic sanctions and providing Ukraine with weapons combined with an absolute refusal to consider US boots on Ukrainian ground is at all like invading Iraq. In contrast, Putin reminds me (and him) of Bush and Cheney. There is a possible invasion which can be explained, if at all, as a result of resentments of past defeats. I actually think the Putin/(Cheney-Bush) analogy is very useful. I will give it two paragraphs (plus one more about how I agree with Noah).

Why did the US invade Iraq ? It would not have happened without 911, but 911 was an excuse not a reason. The advocates of invading had been advocating an invasion since Bush Sr stopped in Kuwait. I think a key issue is that Bush Sr was convinced by Colin Powell not Dick Cheney and this was a rematch. I also think a desire by Bush Jr to match and surpass his father was important. Similarly, I think Putin found the collapse of the Warsaw Pact and the Soviet Union humiliating and is trying to reverse it. I guess there is also some paranoia. I think Bush administration hawks really thought that Saddam Hussein was assisting al Qaeda and I think that Putin really thinks that the Ukrainian revolution was engineered by the CIA and that NATO might actually do something other than prepare for a possible Russian invasion.

On the other hand, one thing which is hard to remember (and was hard to believe) is how many people who were reasonable before 2001 and after 2005 supported the proposal to invade. I don’t understand how that happened (and wouldn’t mind some 20th anniversary mea culpae to be honest). Similarly, I think that Putin isn’t the only Russian who thinks that Putin’s actions aren’t insane. I think it is important to understand war fever, but mainly I agree that the war fever epidemic is currently in Russia.

Noah Smith actually names names and has quotes. There are people who reflexively always blame the USA (one is named Jeremy Corbyn).

Noah Smith also discusses macroeconomics, which is my job. He discusses the mistake made in the past “we then failed to deploy enough fiscal stimulus to boost us out of the post-crash hangover quickly, deepening that recession and extending it by a couple of years” and then the oversimplistic lesson learned. “The government should never be afraid of either deficits or inflation, and instead should always push for higher employment.”

I am going to criticize the second sentence I quoted. First never say someone said never without a quote. The sentence sets up a straw man by asserting that there were people who believe that Germany had no problem with inflation 1918-1923 and that Greece had no public debt problems. The sentence sets up a straw man. Also, in this case, Noah does not name names or quote claims. My more nearly substantive objection is to the word “deficits.” Noah argues that strawman is wrong about the current situation strongly suggesting that the US has a problem with excessive budget deficits. I do not agree. I also note that in the main body of the post Noah discusses inflation, but does not propose fiscal austerity. Rather he argues that the Fed should raise interest rates. He does not, in fact, present an argument the 2020 and 2021 deficits were higher than optimal. I do not think that they were.

I think there were another lesson overlearned 2009-2015 and one lesson which mysteriously not learned. The overlearned lesson was that, sometimes, monetary policy can’t get the job done. At the time (and ever since) some (I mean Krugman as usual) said that a reason to err on the side of fiscal over stimulus is the Fed can always raise interest rates but can’t cut them below zero. I think the other lesson is that QE has very small effects and that many people overestimated how much of the job of stimulus could be accomplished with QE. That is one of my obsessions, I have bored everyone on it, and I will type no more on the topic here.

The point of this post, if any, is that I think that decisions about deficits and inflation are not closely linked. The same aggregate demand can be achieved with low deficits and low interest rates and with high deficits and high interest rates. Noah wrote “Basic Keynesian economics . . . says when you have a booming economy and rapid inflation, you curb aggregate demand with fiscal austerity and tighter monetary policy” (emphasis moine). Keynes did in fact advocate austerity during booms, but basic Keynesian logic says it is time to curb aggregate demand with fiscal austerity and/or tighter monetary policy. There is no reason to assume that fiscal and monetary policy must both be used. In fact, whatever basic Keynesian economics says, Noah Smith writes “fiscal policy poses no inflationary threat.” I assert that it never does, so long as it does not influence monetary policy (called fiscal dominance). Loose fiscal and tight monetary can cause problems, but it does not necessarily cause inflation (in fact Volcker ended the last inflation just as fiscal policy shifted from neutral to expansionary). The logic is “we must each do our part” with no analysis of whose part is properly whose.

I think that Noah is fighting the last war. 2009-2015 it was reasonable to argue that monetary policy was not up to the task and fiscal demand management was needed (I argued this and so did Ur-nonstandard monetary policy Paul Krugman and Aleppo – nonstandard monetary policy Michael Woodford (Ur is used to refer to the oldest city and Aleppo is also very old)). Standard monetary policy could not be used because the Federal Funds Rate was near zero. Now it can be used because the Federal Funds Rate is not near infinity.

I stress this because of Joe Manchin. He argues against Build Back Better on the the grounds that inflation is high. This is a stupid argument not only because monetary policy can be used to fight inflation but also because BBB spending is gradual, spread out over 10 years (as per one of his many demands) and overheating is temporary. Now I am not so naive as to believe that Manchin is really influenced by his arguments let alone Noah’s, but I still object to using “and” instead of “or”.

Another obsession of mine is to point out that the balanced budget multiplier is positive. Equal increases in taxes and government consumption plus investment cause increased aggregate demand (proven as well as anything in macro is by the experiment of the tax financed war in Korea). Standard new Keynesian DSGE models do not consider deficits at all, because they have Ricardian equivalence, so spending matters, but debt v tax financing doesn’t. Those models are silly, but paleo Keynesian models also imply a positive balanced budget mutliplier. In particular, taxes on the rich have a very small effect on aggregate demand as their spending is limited by their time budget not their non-binding dollar budget. Yet economists regularly act as if the full employment deficit is a reasonable measure of fiscal stimulus. One of them is named Noah Smith. He argues BBB “wouldn’t increase deficits much even if it passed.” So what. It would increase aggregate demand by much more than it increased deficits. Still not much this year and next which are what matters. But I do not understand why people who know perfectly well the effect of fiscal policy on aggregate demand does not depend only on the deficit, often write as if it does.

Noah also writes the Fed does not have to bring inflation immediately back to 2% (I totally agree) and writes the aim should be “to keep a lid on inflation expectations and make sure they don’t spiral upward and cause an economically devastating hyperinflation.” No Noah — the US faces a miniscule risk of hyperinflation. Since before Noah was born, I have been reading people suggesting that inflation of 7.5% (or 12%) implies a risk of spiraling into hyperinflation. This is nonsense. Concerted effort is required to achieve hyperinflation. The problem is, except for that, economists can’t explain what is wrong with economy wide inflation (that is increases of all prices and wages). Ordinary people hate inflation, because they assume it does not affect their nominal income (ask Shiller). This is silly. One can calculate costs of inflation due to reduced real balances (shoe leather costs). They are tiny. The claim that policy makers have to worry about hyperinflation solves the discourse dissidence problem that economists would be the subject of even more contempt than we are already if we said 7.5% inflation is no big deal. But it’s no big deal.

And in conclusion, I agree 99.5% with Noah Smith who presented two good posts in one and is clearly right that many are still fighting (to stop) the last war.