Sunday, July 25, 2010

Obama swinging but missing on economic policies

Published in The Tennessean, Sunday, July 25, 2010

Obama swinging but missing on economic policies

by Richard J. Grant

On the economy, there are three areas where the Obama administration and its congressional supporters are failing: fiscal policy, regulatory policy, and monetary policy. They are nothing if not consistent.

1. On the fiscal front, the policy focuses on a hoped-for “stimulus” through increased government spending. The idea is to increase “aggregate demand” by encouraging people to reduce saving and spend more now. Rather than let people do the natural thing at a time of uncertainty and save, the administration wishes to increase their taxes so it can spend the money for them.

It matters what the national government buys for us. Starting from zero, the first dollars spent should go to the highest priorities, such as national security and the essential infrastructures of governance. The desirability of such spending is clear, but as spending increases, the marginal benefits fall. At some point the net benefits become negative. For most other types of government spending, especially the typical pork-barrel project, the first dollar spent yields negative net benefits.

The trouble with “stimulus spending” is that it isn’t working. Nor would a good theorist expect it to work under current conditions. Professor Robert Barro of Harvard University has estimated spending multipliers of “around 0.4 within the same year and about 0.6 over two years.” In other words, the net effect of government spending is to reduce economic activity in one area by $1 in order to increase it by about half a dollar in the area targeted for spending.

The 2009 stimulus package has been financed by increasing government debt, which must be serviced through future taxes. Barro estimates the effect of taxes using a multiplier of minus 1.1, which means that a $1 increase in taxes this year will reduce economic activity next year by $1.10. When adding up the effect over five years, Barro concludes, “This is a bad deal.”

2. Regulatory policy becomes very expensive in ways that go way beyond its budgeted administrative costs. Regulations, though ostensibly enacted to protect people from one another, tend to grow into such a thicket that it is hard, expensive, and too distracting for businesses to serve their customers efficiently.

The biggest costs of the recently passed health-care-reform and financial-regulation laws will be not so much in overt expenditures as in wealth never produced. As things continue to go wrong as a result of these and other regulatory actions, there will be heated political debates over the real causes. These bills have time-bomb effects: they authorize multiple agencies to fill in the details with future regulations. Many of these new regulations will be intended to correct the visible distortions created by earlier regulations.

An administration interested in reducing unemployment, and knowledgeable in good economics, would first remove the existing regulatory overgrowth that is choking innovation and wasting our entrepreneurial energy. Particularly at a time of high unemployment, we need more flexibility, more freedom to act on perceived opportunities and create the voluntary agreements to serve one another that we call “jobs.”

3. Monetary policy centers on the ostensibly independent Federal Reserve System. But the Fed exists at the pleasure of Congress, and its top officers are presidential appointees. Its work is also complicated by the many other agencies and regulations created by Congress. Most notoriously, Fannie Mae and Freddie Mac continue to distort the mortgage market and to drain taxpayers of wealth that might have been put to intelligent use.

The Fed itself acted as expected by providing emergency liquidity to help mitigate the cyclical blowback from its previous looseness. But it is afraid to let go of interest rates and allow them to reflect current market realities. Thus, at a time when we have businesses begging for credit, the Fed is discouraging savers from lending and it is paying banks a quarter percent interest to hold excess reserves at no risk.

That’s three outs for this administration, and we’ve lost this inning.

Richard J. Grant is a professor of finance and economics at Lipscomb University and a scholar at the Tennessee Center for Policy Research. His column appears on Sundays.

Copyright © Richard J Grant 2007-2010