Grasping Reality on TypePad, by Brad DeLong

The danger of premature tightening was illustrated in the US in 1936-37, when the ending of a war veterans’ bonus and the introduction of social security taxes helped push the US back into recession when recovery from the Great Depression was far from complete. The big error of the current discussion is to confuse the budget balances of individuals and companies with the government budget balance, which needs to be in deficit so long as attempted savings exceed perceived investment opportunities. Gordon Brown more or less understands this, and I wish he would use his talents to explain such fundamentals instead of stirring up an outdated class war.

An insightful comment from “Chris” at Felix Salmon’s blog: "The person most willing to take on risk is the one unaware he is doing so. He charges no risk premium.... The resulting market equilibrium is that the guy who is unaware of the risk ends up loaded with it. Then the music stops." As Salmon remarks: "This is possibly a very beautiful and elegant explanation for the extreme profitability of investment banks. They charge their clients a lot of money to take risk off their hands, and then they transformed that risk, using sophisticated financial engineering, into instruments which didn’t, on their face, look risky at all, and which could easily be sold to risk-averse investors. Bingo, massive profits."

In February, when the debate over the economic stimulus package was at its height, a handful of "centrist" Senate Republicans said they'd block a vote on recovery efforts unless the majority agreed to slash over $100 billion from the bill. The group, which didn't have any specific policy goals in mind and simply liked the idea of a small bill, specifically targeted $40 billion in proposed aid to states. Helping rescue states, Sen. Collins & Co. said, does not stimulate the economy, and as such doesn't belong in the legislation. Democratic leaders reluctantly went along -- they weren't given a choice since Republicans refused to give the bill an up-or-down vote -- and the $40 billion in state aid was eliminated. At the time, it seemed like a very bad idea. That's because it was a very bad idea.

Download now or preview on posterous Narayana Kocherlakota, Some Thoughts on the State of Macro.pdf (30 KB) ...

Alas, I didn’t have it wrong — except that unemployment will, if we’re lucky, peak around 10 percent, not 9. There was a lot of talk about health care being Obama’s Waterloo. It won’t, I think and hope. But stimulus is starting to look like Obama’s Anzio — the battle in which the American commander got himself into terrible trouble by being too cautious.

I see the following scenario: a weak stimulus plan, perhaps even weaker than what we’re talking about now, is crafted to win those extra GOP votes. The plan limits the rise in unemployment, but things are still pretty bad, with the rate peaking at something like 9 percent and coming down only slowly. And then Mitch McConnell says “See, government spending doesn’t work.” Let’s hope I’ve got this wrong.

Click here to download: Narayana Kocherlakota, (30 KB) ...