Un-politicizing Fiscal Policy?

Your cyborg economist is ready to flip the switch.

This Op Ed by Peter Orzag at TNR from about a week ago is causing a flurry of tweets back and  forth between people whose blogs I follow like Marcy at Empty  Wheel, Atrios, and Matt Yglesias at TP.  Orzag suggests we work at creating laws to take fiscal policy out of the hands of politicians.  Vast amounts of economic research show that a politicized Fed creates economic havoc in an economy with bad monetary policy. Orzag suggests more automatic stabilizers as a way to depoliticize fiscal policy and get the right prescription to kick in without all the political grandstanding and gridlock.  This means creating laws that work to correct business cycle frictions that make the correct impact without any political and legal action by Congress and the President.  He frames it as embracing less democracy.

In an 1814 letter to John Taylor, John Adams wrote that “there never was a democracy yet that did not commit suicide.” That may read today like an overstatement, but it is certainly true that our democracy finds itself facing a deep challenge: During my recent stint in the Obama administration as director of the Office of Management and Budget, it was clear to me that the country’s political polarization was growing worse—harming Washington’s ability to do the basic, necessary work of governing. If you need confirmation of this, look no further than the recent debt-limit debacle, which clearly showed that we are becoming two nations governed by a single Congress—and that paralyzing gridlock is the result. So what to do? To solve the serious problems facing our country, we need to minimize the harm from legislative inertia by relying more on automatic policies and depoliticized commissions for certain policy decisions. In other words, radical as it sounds, we need to counter the gridlock of our political institutions by making them a bit less democratic.

New York Magazine writer and editor Kurt Andersen wrote similar thoughts on the subject back in 2010 although it’s a broader discussion than just economic policy.

Just as the founders feared, American democracy has gotten way too democratic. This new la-la-la-la-la-la refusenik approach to politics is especially wrong in the Senate, which was created to be the “temperate and respectable body of citizens” that could, owing to its more gentlemanly size and longer terms, ride above populist political hysteria. And it’s ironic that the most effective tool on behalf of tea-party purity, the cloture-proof filibuster, is a crudely undemocratic maneuver, permitting a minority of 41 to defeat a majority of 59. (How fitting that “filibuster” and “tea party” both derive from maritime criminality—to filibuster is to freeboot, or hijack debate like a pirate.) Senate filibusters used to be rare, a monkey wrench used only in cases of emergency, meant to allow debate to continue unimpeded and to protect minority opinion from being ignored. In the sixties, the decade of civil rights and the Great Society and Vietnam, there were never more than seven filibusters during one Senate term; in 2007–2008, scores of Republican filibuster threats resulted in cloture motions. The Democrats aren’t innocent in this downward spiral of truculence: Under Bush, they regularly filibustered to stop the confirmation of judicial nominees. On health care, even though the Senate bill isn’t remotely radical, the Republicans’ refusal to play along at least follows the contours of principle. But on the issue supposedly animating the post-Bush GOP and the tea-partiers, the massive deficit, a bi-partisan Senate bill to establish a bi-partisan commission to rein in future budgets was just defeated with 23 of 40 Republicans voting no—including a half-dozen of the bill’s original co-sponsors. The framers worried about democratic government working in a country as large as this one, and it’s possible that we’ve finally reached the unmanageable tipping point they feared: Maybe our republic’s constitutional operating system simply can’t scale up to deal satisfactorily with a heterogeneous population of 310 million.

Fiscal policy has a notorious inside and outside lag because it has to get through two houses of congress,a President, and then usually through some form of bureaucratic implementation.  It’s been estimated that it can take 2 years to implement.  In comparison, monetary policy general shoots through the economy in about 6 months.  Orzag isn’t exactly suggesting we set up some kind of czar or political commission to deal with economic policy, he suggests we pass more laws that respond to the situation so the situation handles itself a little bit better.  We already have plenty of automatic fiscal stabilizers that do kick in when the economy gets bad–like unemployment insurance–or when it overheats with inflation–like cola clauses–but this is a little more high powered than that.

Automatic stabilizers are features of the tax and transfer systems that tend by their design to offset fluctuations in economic activity without direct intervention by policymakers. When incomes are high, tax liabilities rise and eligibility for government benefits falls, without any change in the tax code or other legislation. Conversely, when incomes slip, tax liabilities drop and more families become eligible for government transfer programs, such as food stamps and unemployment insurance, that help buttress their income.

This would build in more fiscal responses to business cycle fluctuations by law.  Here’s a few more specifics from Orzag.

What we need, then, are ways around our politicians. The first would be to expand automatic stabilizers—those tax and spending provisions that automatically expand when the economy weakens, thereby cushioning the blow, and automatically contract as the economy recovers, thereby helping to reduce the deficit. A progressive tax code is one such automatic stabilizer. The tax code takes less of your income as that income declines, so after-tax income tends to decline less in response to an economic shock than pre-tax income. Since spending is based on after-tax income, the impact on the economy is cushioned. Alan Auerbach of the University of California at Berkeley has found that, as a result, the tax code has, over the past 50 years, offset about 8 percent of the initial shock to GDP from economic downturns. For the same reason, making the tax code more progressive would strengthen its role as an automatic stabilizer. Unemployment insurance is another automatic stabilizer; as the economy weakens, unemployment insurance expands, providing a boost to demand right when the economy needs it. Other automatic stabilizers are possible as well. For instance, rather than simply extending and expanding the existing payroll-tax holiday, as President Obama has proposed, policymakers should permanently link the tax to the unemployment rate. Consider a system under which the payroll tax would be reduced by 6 percentage points whenever the quarterly average unemployment rate exceeded 7.5 percent or increased by more than 2 percentage points over the previous year. Since a cut in the payroll tax is a powerful form of stimulus, this would be a built-in way to ensure a quick and effective government response to an economic downturn.

I’m not convinced payroll tax cuts are powerful, but that’s just an example for Orzag given his role in the Obama policy making group until recently. Is that a good idea and is framing it as less democracy a bad sell?

Here’s the criticism from Empty Wheel.

Peter Orszag opines from the politically sheltered comfort of his gig at Citigroup that we have too much democracy.

I’ll say more about specific claims he makes below, but first, let me point out a fundamental problem with his argument. He suggests we need to establish institutions insulated from our so-called polarization to tackle the important issues facing this country. That argument is all premised on the assumption that policy wonks sheltered from politics, as he now is, make the right decisions. But not only is his own logic faulty in several ways–for example, he never proves that polarization (and not, say, money in politics or crappy political journalism or a number of other potential causes) is the problem. More importantly, he never once explains why the Fed–that archetypal independent policy institution–hasn’t been more effective at counteracting our economic problems.

If the Fed doesn’t work–and it arguably has not and at the very least has ignored the full employment half of its dual mandate–then there’s no reason to think Orszag’s proposed solution of taking policy out of the political arena would work.

As you undoubtedly know, I can’t agree with her take on the Fed because I’ve just seen way too much research and history of other countries with central banks that have been politicized and the results are horrible.  I think that the statement she makes after the charge of “archetypal independent policy institution” isn’t a sound argument.  She’s mistaking the impotency of monetary policy in the face of a liquidity trap for problems with the Fed itself.   All you have to do is google central bank independence and you’ll get the decades old studies that show just how bad it can get if there’s a central bank invaded by pols.  The Fed needs to be monitored but it no way should any politician get close to the Open Market Committee.  She makes her usual great points though and it’s worth the read.

So, there’s some food for thought.  Chew Away!

A Mighty Stimulus

wpa-alabamaI’m going to be a bit more wonky than usual because I’m going to be making the case that we may need a bigger stimulus package that either the Democratic party or Republican party may be prepared to pass.  Right now, it appears the only thing that will get by the Senate right is a package of extended unemployment benefits.  I’m going to have to use two concepts that are extremely important to fiscal policy that make all undergraduate students tremble.  The first is the concept of a fiscal policy multiplier.  The second has to do with sorting through labor markets to get at more than just the unemployment rate to find possible ‘automatic stabilizers’.   Both are tedious exercises in basic economics.  Both have never been so significant as now due to some structural changes in the U.S. economy since the 1980s.

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