Was that liberal enough for you?

It was nothing if not bold. Far from sliding away from his promise to reform healthcare, Obama affirmed it by proposing a $635 billion "downpayment" on the cost, financed about equally by high-income taxpayers and by squeezing Medicare payments to private providers. To announce an initiative of that scale and scope in the same budget that predicts a $1.75 trillion deficit in 2009, and a full-employment deficit of 3% of GDP even after ten years of brisk recovery and steady growth, took some nerve. Obama clearly has plenty. Left-leaning Democrats who have spent recent weeks moaning about centrist appointments and attempts at outreach to Republicans should hang their heads in shame. This is the budget they have been dreaming about for years.

I am not what you would call an instinctive leftist Democrat, yet so far as substance goes I like a great deal of what is there. The intelligence of this administration shines through at many points. My objections are mostly about the gaps.

Continue reading "Was that liberal enough for you?" »

It depends what you mean by nationalize

Not even the most generous observer would say that the Treasury and the Fed have done a good job of explaining the thinking behind their financial stability plan. I think this note by Douglas Elliott does a much better job than they have. If you want to understand the logic of the administration's position, have a look.

On the underlying analysis, Elliott is with Geithner and Bernanke most of the way, which lately puts him in the minority of commentators. The main difference is that he is willing to say that outright nationalization might be necessary for "one or two" large banks, whereas Geithner and Bernanke persist in giving the impression that they will avoid this if at all possible. Most economists who follow this subject now seem to be arguing for outright nationalization of many banks--or, as they put it, "the banks" (choose your own number). People often seem to be talking past each other. Elliott persuades me that some of the discussion of the Fed/Treasury plan is muddled by terminology.

This week Bernanke said nationalization is "when the government seizes the bank, zeroes out the shareholders, and begins to manage and run [the] bank, and we don't plan anything like that... I think that this debate over nationalization kind of misses the point." ("Bernanke Pushes Back Against Nationalization", said the headline in the WSJ.) But he does not exclude bigger public stakes (with taxpayer upside) and strong control rights: indeed, that is what he is proposing. So, as Elliott says, a lot depends on exactly what you mean by nationalization.

Elliott also explains the "franchise value" and "legal complexity" arguments for avoiding full nationalization unless it is really necessary; Bernanke mentioned those points in testimony this week but did not elaborate. The paper carefully goes through the pros and cons of full nationalization. I've been leaning towards that solution but the paper did make me pause. This is how it wraps up.

It] may prove necessary as a last resort for one or two of the larger banks, but should only be undertaken when, and if, it is clearly necessary. More widespread nationalization is unlikely to be needed unless the economy performs substantially worse than most economists expect. Although we all crave certainty, it would be better to wait until we knew that this pessimistic case was likely before nationalizing more widely, given the serious social and financial costs of that extreme step.

Beyond the very small number of full nationalizations that may prove necessary, it may well make sense for the government to take substantial stakes now in additional large banks in a form that some may view as a partial nationalization. The Administration's plan to perform a rigorous, uniform "stress test"on the nation's largest banks is a good one...

[If] it becomes clear through the stress test that a bank is already insolvent or is at high risk of becoming insolvent, then it would be better to go directly to the step of full nationalization...

Many observers would say that most of the banking system is "already insolvent" or "at high risk of becoming insolvent". The Fed and the Treasury evidently think otherwise. ("If a bank does become insolvent then the FDI, of course, will intervene," Bernanke said on Tuesday, "but we're not close to that. All the banks are above their regulatory capital.")

Perhaps Citi and Bank of America--to name two large banks--are or will be insolvent on any plausible scenario; for the rest of the industry it still hinges on the timing and strength of the recovery. Hence the Fed/Treasury stress test. Is the "adverse" case in that exercise--an output decline of 3.3% this year and 10% unemployment in 2010--adverse enough to tell us what we need to know? I wonder. It's not difficult to imagine a worse case than that.

Anyway, take a look at Elliott's article. Even if you don't agree with the conclusion, I think you'll find it helps to clarify the issues.

Obama's state of the union

Much as I admire Obama, the thought that would not leave me alone as I listened to his speech was "diminishing returns". It was a good campaign speech, beautifully delivered, and helped by the very flattering comparison with Bobby Jindal's weirdly robotic response. (How do they get people to accept this assignment?) But it was a speech we have now heard many times. The instant polling suggested that listeners loved it, which surprised me a little. People are inclined to be patient with Obama and know he is not to blame for the mess, but I wonder how much longer they will love this kind of speech. This time next year, an address so heavy on inspiration and so light on policy surely is not going to work.

Granted, one month in, Obama has on the books a massive and mostly good stimulus bill. It is not quite as big or as front-loaded as it looks, or as it should be--see my recent column in National Journal on this [link expires in ten days]. But a president who has got this done can hardly be accused of inactivity. High marks, then, on the stimulus. But where is the banking plan, without which the stimulus won't work? Barring a perceptible uptick in the anti-banker rhetoric, nothing new on that in the speech.

We heard increasingly confident commitments on healthcare reform, education reform, and alternative energy--all of them potentially very costly, with expenses going way beyond the supposedly temporary provisions in the stimulus. This alongside a restatement of the new promise to halve the deficit to around $500bn by the end of 2012. I am struggling to see how those things fit together, unless Obama is planning much bigger tax increases than he has so far indicated. And, by the way, why promise to halve the deficit by 2012 in any case? Premature efforts to rein in the  budget deficit pushed Japan back into recession during its Long Slowdown. It is too soon to know when or how quickly borrowing should be brought back under control. But it is not too soon to start thinking about how it should be done, when the time is right. I don't doubt that the administration is indeed thinking hard about that. It just isn't telling anybody else just yet.

Maybe the budget "blueprint" will tell us more...

Obama's fiscal policy

In this column for the Financial Times, I say that once the recovery is secure, taxes are going to have to go up--and not just on the top sliver of incomes.

This year's budget deficit will be about $1,400bn or roughly 10 per cent of gross domestic product. This comprises $1,200bn, as recently estimated by the independent Congressional Budget Office, plus another $200bn from the first year of the fiscal stimulus. What happens after that? A new analysis for the Brookings Institution by Alan Auerbach and William Gale estimates that the deficit will average at least $1,000bn a year over the next decade - and this on the basis of some pretty optimistic assumptions.

It assumes an orderly recovery, much as from previous recessions: no lost decade of slow growth. It assumes that the provisions in the stimulus law expire when the act says, even though the administration and Congress hope to make many of them permanent. It takes no account of new outlays under the housing plan or the forthcoming financial stability plan. And it assumes the administration does not embark on comprehensive healthcare reform, even though the White House insists it will.

Even under these favourable assumptions, an annual deficit of $1,000bn or more persists. The Auerbach-Gale study also looks further ahead and estimates a "long-term fiscal gap" - "the immediate and permanent increase in taxes" that would be needed to keep the ratio of government debt to GDP constant at its current level. Under those same favourable assumptions, the necessary tax increase is between 7 per cent and 9 per cent of GDP, about equal to the take of the present federal income tax.

This is not to argue against a short-term stimulus. For now, it makes sense to let the debt rise. If anything, the US economy needs a bigger jolt than it will get from the law Mr Obama signed last week. Yet the longer the fiscal gap is allowed to persist, the harder it will be to close. The question is whether, once the recovery is secure, deliberate action can restore fiscal balance before a new crisis forces a draconian response on this or some other administration...

Obama's fiscal responsibilty summit was first-class theater, but did not advance the discussion very far. Mind you, I don't think that the theatrical aspect is bad or unimportant. On the contrary. As I've argued before, a big part of what Obama has to do is speak to the general public over the heads of Congress about what needs to be done. That is what events like yesterday's are about. Treating political opponents courteously and radiating calm non-ideological pragmatism are the way he gets the country behind him. But he has to align opinion behind the correct, challenging, substantive policies, not merely behind a mood of can-do co-operation. If you do that and nothing else, you are Tony Blair.

On long-term fiscal consolidation, I don't see much honesty as yet on what it will take to deal with the problem. Obama's thinking seems to boil down to greater efficiency and higher taxes on the rich. That will be insufficient even to close the current-policy deficit, let alone pay for all the big new things (universal health care, affordable college for all, etc, etc) Obama wants to do.

I also think it is a mistake to promise to halve the deficit by the end of the first term--even supposing he could do it. If this is an unusually prolonged recession, as it may well be, this  timetable is much too fast. He needs to retain the flexibility to keep fiscal policy loose for as long as necessary. You move to fiscal consolidation when the recovery looks solid, not according to the demands of some pre-arranged schedule. You show you are ready to do it when circumstances allow, rather than promising to do it regardless.

Some thoughts on the housing plan

The administration's housing plan seems well thought out. All three parts address clear weaknesses in the present arrangements.

The refinancing element, aimed at borrowers in good standing, allows Fannie and Freddie to refinance loans where the value of the mortgage is between 80% and 105% of the value of the property. Up to now they have not been allowed to do this (unless the mortgage is insured). Many borrowers in good standing have seen their loan-to-value ratios climb into this range because of falling house prices. The rule preventing refinancing at current lower rates is self-defeating from the agencies' own point of view, since it increases the chances of default. The plan puts this right--helping both the GSEs and their borrowers. (Some complain that the change only helps borrowers with loans owned or guaranteed by the GSEs. Well, yes, those were the loans affected by the restriction in the first place.)

The loan modification part is aimed at borrowers who are at imminent risk of default, and is modeled on the scheme that the FDIC has been testing and advocating for some months. An explicit public subsidy is involved--to the tune of $75 billion--which in effect will be split between lenders/servicers and qualifying distressed borrowers. Lenders and servicers get cleverly structured incentives to reduce monthly repayments to 31 percent of gross income. (Note that modifications up to now have been few and far between, and have often left repayments unchanged or higher than before, once penalties and arrears have been added back.) Lower repayments obviously lessen the risk of default.

The administration says that its scheme does not reward people who recklessly borrowed too much. This is untrue: the plan will certainly help some people who borrowed more than they should have. No doubt, it would be fairer to help only borrowers whose standard repayments (after teaser rates expired) were no more than say 30 percent of gross income to begin with, and/or who borrowed less than 80% of their property's initial value--in other words, to help only borrowers who behaved prudently, and who are now in trouble because their income has fallen. But of course this would have meant many more defaults. Because foreclosures also hurt innocent bystanders, there is a public interest in limiting them. The second part of the plan, I think, is indeed unfair and does raise moral hazard concerns--but I'd say that is a price worth paying if it stems the tide of foreclosures.

Will it succeed in doing that? It certainly gives loan modification a much firmer push than seen up to now. Lenders will not be forced to modify, but TARP beneficiaries will have to apply the guidelines, and show that they are making an effort. The new prospect of bankruptcy-court cramdowns (this requires legislation) should  also help to focus minds. A standard Treasury-endorsed modification template ought to ease some of the worries servicers have about being sued by investors over unauthorized modifications of securitized mortgages. An important question is how far cuts in repayments will be achieved by interest-rate reductions as opposed to cuts in principal. Many observers reckon that principal reductions would curb foreclosures more effectively. The plan sees principal reductions as a possibility, but the incentives appear to grant that method of reducing repayments no special favors. Maybe this will have changed by the time we get full details of the plan next month.

The third part--$200 billion of new capital for the GSEs--improves Fannie's and Freddie's ability to buy mortgage-backed securities, supports the market value of those securities, and keeps downward pressure on the interest rates lenders charge mortgage borrowers. This too makes sense.

I'm sure the plan will reduce the rate of foreclosures--as compared with a no-plan baseline. How much it will reduce them, and whether that will be enough to stabilize the housing market, is impossible to say just yet. But after many months of almost total neglect, this is a big step forward.

Is 1,400 pages a problem?

My friend Stan Collender, who knows more about the budget process than anybody else I can think of, says my wife is wonderful but takes me to task for my remarks on the length of the fiscal stimulus bill. (Paul Krugman, quite unappeased by my accusing Republicans of hypocrisy on the point, congratulates him on a "fine takedown".)

What Clive seems to be saying is that, at 1400 pages, the bill could not possibly have been reviewed in detail by many members of Congress before they voted for it given the rush to get it done.  What he doesn't say is that most representatives and senators generally only review the parts of any bill that are important to them for some reason...

[C]iting the number of pages as a reason to think legislation is bad is ridiculous.  That's on a par with football commentators talking about the number of minutes one team has had the ball compared to the other or the greater number of plays one team has run.

Stan, please, read what I wrote:

[F]ailing to read the law you are voting for is standard working method in Congress. But that doesn't invalidate the criticism, certainly not in the eyes of the public. Not every unread piece of legislation costs taxpayers $800 billion. It isn't too much to ask that the politicians voting for this law, even if they had to make an exception, had read it first.

Well, is that too much to ask? The point is not length as such, obviously, but length in relation to time for consideration. In that very post I said that, on balance, I am for this measure. So I can hardly be accused of saying that any 1,400 page law must be bad. But I cannot think that passing such an enormously expensive and complicated piece of legislation in such a frantic rush is good government--even if it is standard practice.

(Paul reminds us that "War and Peace" is both very long and very good. That made me think of the Woody Allen joke about the fellow who took a speed-reading course and then read the novel. "It's about Russia.")

(Stan also has a wonderful wife, by the way.)

Book review: Animal Spirits by Akerlof and Shiller

[From Monday's FT]

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism
By George Akerlof and Robert Shiller
Princeton University Press, $24.95

This is a good moment to propose a re-examination of orthodox economics. The current breakdown, possibly the worst since the Great Depression, was a shock to all but a handful of economists. It calls into question much of what they thought they knew.

Why did things go so wrong? What should governments do now? How do we stop it happening again? In their new book, two of the most creative and respected economic thinkers currently at work, George Akerlof and Robert Shiller, argue that the key is to recover Keynes's insight about "animal spirits" - the attitudes and ideas that guide economic action. The orthodoxy needs to be rebuilt, and bringing these psychological factors into the core of economics is the way to do it.

Topicality can be a mixed blessing. The book was mostly written before the crisis became acute. A little awkwardly, the authors have tacked an excellent postscript, about what needs to be done, on a chapter about monetary policy. The connections between their thinking on the limits to conventional economics and the issues thrown up by the breakdown are plain, even if they were unable to make every link explicit. Even more than Akerlof and Shiller could have hoped, therefore, it is a fine book at exactly the right time.

Though it calls for a reworking of economic theory, Animal Spirits is not a difficult book. It is short, chatty and anecdotal. The general reader will be engaged and drawn in. But the book is serious, too. Good notes and a bibliography are a guide to the literature that the book aims to tie together. Animal Spirits carries its ambition lightly - but is ambitious nonetheless. Economists will see it as a kind of manifesto.

The first quarter divides animal spirits into five categories. They are confidence, whose role is pervasive and which stars throughout the rest of the narrative; fairness, which influences wage-setting and the working of the labour market; corruption and bad faith, which can especially affect financial markets; money illusion, the propensity to be fooled by inflation; and "stories", which they could have called "culture", a catch-all for economically significant ideas about the world and one's place in it.

The rest of the book shows how thinking about these animal spirits yields answers to big questions that perplex orthodox economics - or force it to make bizarre and implausible assumptions. Why do economies fall into depression? Why is there unemployment? Why are financial prices so volatile? Why does the property market go through cycles? Why are minorities often especially poor? The answer in each case is partly, and sometimes mainly, animal spirits

Chapter by chapter, the analysis is fascinating and usually persuasive. Whether the larger project can be made to hang together, though, I doubt. The authors' criticisms of the standard model are well taken and not that controversial. The orthodoxy assumes rational optimising behaviour, and is reluctant to contemplate more than minor deviations from that principle; as a result, it often goes astray. Ad hoc modifications, such as those the authors suggest, may get better results.

Without saying how, the book aspires to go further and calls for a new standard model. That is hard to envisage. The assumption of rational optimisation is a gross simplification, no doubt, but despite all the drawbacks emphasised in the book, it has been a highly productive one. Shiller and Akerlof would be the last to deny the power of the insights it has yielded. At issue is whether a psychologically enriched standard model would be too complex to offer useful simplifications. The standard model plus ad hoc modifications suited to the particular case might be the best economics can do.

A different problem arises in moving from explanation to prescription. Akerlof and Shiller argue convincingly that animal spirits give a richer and truer account of economic fluctuations. How to manipulate them for policy purposes, and when it might be right to try, are separate questions. The authors are doubtless sympathetic to the case for "libertarian paternalism" in Nudge, by Richard Thaler and Cass Sunstein - another valuable book that explores the possibilities of "behavioural economics". What the two have in common is the idea that once you take account of animal spirits, people can be guided, without being forced, to do what is in their best interests.

The question is, what about the claims of liberty? Likening the role of government to a parent's duty to create a happy home, the authors write: "The proper role of the parent is to set the limits so that the child does not overindulge her animal spirits." This is an unappealing analogy. I would sooner take up arms against a government that saw me as a child than vote for it.

Obama and the search for consensus

My latest column for the FT argues that Obama should not give up on seeking consensus. This is where the piece ends up:

In each case - fiscal stimulus, financial stability and fiscal consolidation - the government has to get in front of the problem and confront it decisively. An unprecedented crisis calls for unprecedented remedies and they have to be in place before the need is self-evident. More than it has so far managed, the government must anticipate, not just react. Given the scale of the interventions, this is difficult, especially in a democracy as slow and attuned to public opinion as the US.

This is why Mr Obama is right about the need for consensus and why the partisans on both sides of Congress are wrong. The government as a whole must lead public opinion. Before the worst happens, it must convince voters that powerful fiscal stimulus is needed. Before the worst happens, it must tell voters why many more hundreds of billions of taxpayer dollars will be needed to stabilise the financial system. Before the worst happens, it must persuade the public that bringing borrowing back down in due course is necessary.

If Congress chose to focus more intently on those imperatives - deeming issues such as whether to cut taxes or raise spending as secondary for now - it could help to unite the public behind bold timely action. But it chooses otherwise, perhaps because it fails to see the peril, which puts the whole burden on the president.

Anticipation is not a strength of this system. Institutionally and temperamentally, it prefers "too little, too late".

You can read the full article here.

Fiscal stimulus: repent at leisure

The administration was right to press for a big fiscal stimulus, I think, and it is better to have the bill that emerged from Congress than none. (The FT called it ugly but necessary: I couldn't have put it better myself.) Still, if ever a rushed extravagant purchase was likely to induce a touch of buyer's remorse, it is this one.

Republicans have a point when they complain about the inordinate length of the bill--1,400 pages or thereabouts (the count does not seem to have settled down yet). Republicans are right to say that not a single senator or congressman voting for it can have read it. Of course, it is hypocrisy for them to say this: failing to read the law you are voting for is standard working method in Congress. But that doesn't invalidate the criticism, certainly not in the eyes of the public. Not every unread piece of legislation costs taxpayers $800 billion. It isn't too much to ask that the politicians voting for this law, even if they had to make an exception, had read it first.

It will be interesting to see what is hiding in those 1,400 pages. Some disturbing early discoveries have already been reported. For instance, the bill appears to reverse or at any rate undermine the Clinton welfare reforms. It appears to ban the hiring of skilled immigrants in much of the finance industry. It appears to cap finance-industry pay much more aggressively than the Obama administration has proposed. Even if you don't think these ideas are harmful or unworkable or both, as I do, you have to admit that they deserved more of an airing than they received--which is virtually none--before they became law.

Not exactly a vote of confidence

Watching Geithner I recalled that the president had declined to take questions about the new financial stability plan at his press conference on Monday. He didn't want to steal the spotlight from the Treasury secretary on Tuesday, he said. He jokingly urged the press to turn up for that: "He will be terrific." Well, he wasn't, and I'm not just talking about the anxious hesitant delivery.

What Obama said on Monday struck me as a bit odd at the time, as though he was most concerned about the performance aspect. Now it seems odder. The president knew what we now know, that the next stability plan does not yet exist. The breathless build-up for today's announcement had led everybody to expect an actual plan. When the Treasury said, "We're still working on it," Wall Street recoiled, and the White House should not be surprised.

On the substance I agree with most of what Martin Wolf says--though I think he greatly underestimates Obama's difficulties. Martin finds it astonishing that Obama failed to dictate the terms of the fiscal stimulus to Congress, or that his team is looking for a way forward that avoids (at some cost in added timidity) the need for new Congressional approvals. I recommend a reading of the constitution. It is very short and very clear. Obama simply cannot do what Martin wants him to. This is not the UK. Obama cannot dictate the law as though Congress were not there.

Public opinion is a big problem too. US politicians have a terrible habit of paying attention to it. If the country is set against Obama's remedies, getting those policies enacted will be extremely difficult. This is why nationalising insolvent banks, and acknowledging the costs upfront, is a nettle the administration is not yet willing to grasp. On the other hand, if Obama can get the country behind the bolder measures that Martin and I think are necessary, Congress would go along. But this step of persuading the public cannot be skipped. If Obama stakes it all and projects the uncontained sense of alarm that Martin feels (as do I), and the public chooses not to go there, he has lost them and his presidency is over--and we still won't have the right policies.

It is true that the biggest mistake the administration can make is to do too little. The point is, it may have no choice but to do too little.

Which brings me back to reservations I have already expressed about the economics line-up in the administration. Obama is not at home with financial and economic policy. On these issues, for all his talents, he does not speak authoritatively. His posture is, "I rely on my experts." I don't think that's going to work. There are too many of them, and nobody has so far emerged as the principal spokesman. Geithner was up for that part, of course. His troubled confirmation set him back, though. While he is an exceptionally able guy, this morning he did not look as though he has the necessary salesmanship. Meanwhile, the man regarded as the dominating intellect--Larry Summers--has been keeping a lowish profile.

If economists outside the administration weren't so busy squabbling among themselves, perhaps they could help. I watched Paul Krugman and Ken Rogoff on the PBS News tonight. They were excellent; they were clear; they made the same criticisms of the plan that I just did: that Geithner forgot to bring it. Consensus! More of that could do some good. (There, Paul, my hysteria has subsided.)

Dismal science, revisited

Paul Krugman and Robert Barro have both responded to my column accusing them of putting politics first. Paul wonders what has happened to me.

Continue reading "Dismal science, revisited" »

Son of TARP

[This comment appears in Wednesday's FT.]

The Obama administration knows that the politics of its new Financial Stability Plan is even more difficult than the economics--which is saying something. The country detests the Troubled Asset Relief Programme, now recast and renamed, regarding it as a vastly expensive rescue of the people who caused the crisis. Tim Geithner acknowledged this on Tuesday. The administration had to improve and expand the programme, while persuading voters that costs will be controlled and that the villains will be punished. The goals are complicated, and the result is a bit of a mess.

The caps on pay of banking executives announced earlier, though far milder than taxpayers have been led to think, are part of the strategy. The new plan, which will use Treasury money to seed new commitments from the private sector and the Federal Reserve, also has politics much in mind. Some $350bn remains unspent in the TARP. The idea is to use it to mobilise new Fed lending and private participation in the resolution of toxic assets. This way the $350bn might be stretched to $2,000bn and up with no need for new Congressional approval.

The plan is anything but finished. Mr Geithner announced principles that will guide it, nothing resembling  a worked-out scheme.

The Fed side is reasonably straightforward. It involves expanding an existing programme, the Term Asset-backed Securities Loan Facility, which lends to investors in securitised car, student and credit-card loans. The scope of the TALF will be widened. The Treasury will put some more money in, shielding the Fed from the first layer of risk. Whether this will be enough to protect the Fed's balance sheet remains to be seen.

The other main innovation is the plan to create a public-private fund to acquire bad assets. This raises many more questions than the expanded TALF. What terms and conditions will the Treasury offer its private partners in the venture? There are plenty of bad assets out there already for investors willing to buy them. The new inducement seems to be guarantees. The Treasury can stretch the TARP money a long way by guaranteeing the bad assets: this could certainly draw in lots of new private capital. It would also leave taxpayers on the hook for potentially very large sums if things do not work out as intended.

Mr Geithner did not go into that, or explain how taxpayers would participate in the upside if things go well. Despite the insistence on transparency, one wonders if investors will be offered a better deal than taxpayers will be led to think. More forthright approaches--including nationalisation--might end up costing taxpayers less, but the administration has apparently decided that they would be much harder to sell. And Mr Geithner's assurance that his scheme will "help provide a market mechanism for valuing assets" is puzzling. The terms of the guarantees or subsidies attached to the toxic assets will decide what they are worth--and what this new plan, once it has been worked out, is really going to cost.

The dismal science, abridged

My new column for the Financial Times asks, where is economics when you need it?

I used to have no time for the idea that economists never agree, so economics must be a bogus science and a waste of time. Of course economists disagree, I would say. Economics is difficult, and by its nature cannot be as clear-cut as the physical sciences. But it strives to meet the most rigorous standards of evidence-gathering and scientific method. As long as it remains aware of its own limits, one should not mock the discipline for aiming high.

Economists are right to disagree. This does not stop them improving public policy or raising the standard of discussion inside and outside the profession. Judge them by those standards, I used to say.

As a lapsed member of the guild - I had a spell as an economist in the British civil service - I have a lingering sentimental attachment. But my earlier confidence that economists are not wasting their own and everybody else's time is diminishing. Are the leaders of the profession measuring up to the standards I just mentioned? Are they helping to improve policy, or raise the standard of public understanding? You could easily argue the opposite.

Economists are failing to express anything resembling consensus on the most basic questions of economic policy. Is fiscal stimulus desirable, or even possible? Some say yes, some say no. In a recession, is it best to cut taxes or raise spending, or both, or neither? They disagree about that. How should governments mend their broken financial systems? They disagree about that too.

I had thought they would at least agree that raising trade barriers at a time like this must be a bad idea. Then I read Paul Krugman, Nobel laureate, Princeton professor, and New York Times columnist, explain that raising tariffs - though perhaps unwise for other reasons - "can make the world better off". "There is a short-run case for protectionism," he went on, "and that case will increase in force if we don't have an effective economic recovery programme." What are his readers to make of this? Are all the economists who say otherwise just wrong?

This impression of disarray - that economics has nothing clear to say on these questions - is not the fault of economics as such. It is a mostly false impression created by some of its leading public intellectuals, Mr Krugman among them.

Economics outside the academy has become the continuation of politics by other means. If you wish to know what Mr Krugman thinks on any policy question, do not read his scholarly writings; see which policies are advocated by the progressive wing of the Democratic party. Mr Krugman agrees with liberal Democrats about most things, and for the rest gives as much cover as the discipline of economics can provide - which, given its scientific limitations, is plenty. He does this even on matters where, if his scholarly work is any guide, the economics is firmly against his allies. Liberal Democrats are protectionists. Mr Krugman is not, but politics comes first.

The syndrome affects economists on the right as much as on the left. Just as there is a consensus among economists that protectionism should be opposed, most economists believe that a powerful fiscal stimulus is both possible and desirable in present circumstances, and that the best stimulus would include big increases in public spending. Yet recently, Robert Barro, a scholar with conservative sympathies, wrote in the Wall Street Journal that this view was an appeal to "magic".

The problem is not that Mr Krugman questions the consensus on trade (if indeed he does), or that Mr Barro questions the consensus on fiscal policy (as he certainly does). It is that both set the consensus aside so carelessly. In doing so, these stars of the profession destroy the credibility of their own discipline. Mr Krugman gives liberals the economics they want. Mr Barro gives conservatives the same service. They narrow or deny the common ground. Why does this matter? Because the views of readers inclined to one side or the other are further polarised; and in the middle, those of no decided allegiance conclude that economics is bunk.

Politics and economics are always difficult to keep apart. But the problem is getting worse, perhaps because political splits are deepening, or perhaps because the lack of disinterested economic advice is more keenly felt with so much at stake.

The web, for all its blessings, is an aggravating factor. Many of the most successful economics blogs promote communication within political groupings, not across them. On the web you best build an audience by organising a claque and stroking its prejudices. Extend elaborate courtesy to people you agree with and boorish contempt to those who do not get it. Celebrate exasperation and incivility as marks of intellectual authenticity - an attitude easier to tolerate in teenagers under hormonal stress than in professors at world-class universities.

Consensus economics does exist. The Obama administration and the Federal Reserve are trying to apply it. The economics professoriate has an obligation to criticise and improve those policies. But if politics is allowed to split the discipline, and communication across that divide continues to break down, the science of economics will forfeit what little respect it still commands.

Protectionism and the stimulus

My new column for National Journal attacks the Buy America language in the fiscal stimulus bills [the link expires in two weeks].

During the past few months, as the severity of the recession has become clearer, drawing parallels with the Depression of the 1930s has been a staple of economic commentary. Rightly so: This may yet turn out to be the worst economic setback for 70 years, and the Great Depression says something about how bad things can get if governments fail to respond quickly and about the need to learn from history.

Speaking of that, remember Smoot-Hawley? One can overstate its role, no doubt--it did not actually cause the Depression--but most economists, I think it fair to say, believe that the effort in the 1930s to boost domestic output by restricting imports made things worse. The collapse of world trade, and hence global output, was helped along by deliberate policies in the United States and abroad, as governments tried to keep employment high at home by shifting unemployment overseas. In the end, everybody was worse off.

I had thought this lesson had sunk in. Smoot-Hawley is a byword for economic incompetence and illiteracy. In a global slowdown, "Beggar thy neighbor" is a formula for disaster. Who dissents? The issue, I had supposed, arouses no controversy--causing far less disagreement than how to mend the banking system; less than whether a big fiscal stimulus is needed to revive demand; and less than whether tax cuts or increases in public spending are the best way to stimulate. Yet both the House and the Senate have drafted stimulus bills that include protectionist "Buy American" language. The spirit of Smoot-Hawley lives.

You can read the rest here.

Obama on bankers' pay

I thought his statement was good.

We all need to take responsibility. And this includes executives at major financial firms who turned to the American people, hat in hand, when they were in trouble, even as they paid themselves customary lavish bonuses. As I said last week, this is the height of irresponsibility. It's shameful. And that's exactly the kind of disregard of the costs and consequences of their actions that brought about this crisis: a culture of narrow self-interest and short-term gain at the expense of everything else.

This is America. We don't disparage wealth. We don't begrudge anybody for achieving success. And we certainly believe that success should be rewarded. But what gets people upset -- and rightfully so -- are executives being rewarded for failure, especially when those rewards are subsidized by U.S. taxpayers, many of whom are having a tough time themselves.

For top executives to award themselves these kinds of compensation packages in the midst of this economic crisis isn't just bad taste -- it's bad strategy -- and I will not tolerate it as President. We're going to be demanding some restraint in exchange for federal aid -- so that when firms seek new federal dollars, we won't find them up to the same old tricks.

As part of the reforms we're announcing today, top executives at firms receiving extraordinary help from U.S. taxpayers will have their compensation capped at $500,000 -- a fraction of the salaries that have been reported recently. And if these executives receive any additional compensation, it will come in the form of stock that can't be paid up until taxpayers are paid back for their assistance.

Companies receiving federal aid are going to have to disclose publicly all the perks and luxuries bestowed upon senior executives, and provide an explanation to the taxpayers and to shareholders as to why these expenses are justified. And we're putting a stop to these kinds of massive severance packages we've all read about with disgust; we're taking the air out of golden parachutes.

Shame about "taking the air out of golden parachutes"--not quite right. But now that taxpayers are shareholders, I think the substance is hard to quarrel with. And I liked the "This is America" paragraph, which I think judges the country's mood very well. This indeed is not about disparaging wealth or pay for performance, but about curbing rewards for failure, something Wall Street seems incapable of doing for itself. Quite where this policy goes beyond the short term, we shall see. (As this FT editorial argues, some broader questions need to be addressed.) But an immediate political necessity had to be confronted and it has been.

If he now kills the Buy American provision in the fiscal stimulus, I will be even more impressed.

In Search of Jefferson's Moose, by David Post

This is a book that might have passed me by if the Cato Institute hadn't invited me on to a panel today to talk about it. Subtitled "Notes on the State of Cyberspace", it is a quirky and improbable work, and evidently a labour of love: reflections on Jeffersonian ideas of freedom interwoven with an essay on the law, culture and politics of the internet. A difficult book to summarise, but a remarkably successful one, I think. I loved it.

The moose in the title is the preserved animal, seven feet tall at the shoulder, that Jefferson had shipped over to Paris when he lived there to rebut the popular notion that the New World's creatures were smaller than (thus inferior to) their Old European counterparts. I refute it thus. Jefferson had seemingly limitless intellectual interests, but was much preoccupied with the awesome spaces beyond the frontier. The moose was partly meant to jolt his European visitors into thinking about the limitless possibilities of the new. To start with, Post wants to do something similar for modern readers: look at the internet afresh, and be amazed.

The book then thinks through Jefferson's ideas about law and the prospects for an "extended republic" of free self-governing societies, and finds applications to the internet. What would Jefferson have made of it all? Seeing the questions reframed in this way is enlightening. Post, a law professor at Temple University, has classical liberal leanings, but doesn't offer cut-and-dried answers to questions about privacy, anonymity, free speech, private and public regulation, and all the other legal and political issues that cyberlaw specialists engage with, but he gets you thinking about them in a new way. I recommend this strange and absorbing book very warmly.

Here is a fuller review.

The reckless stupidity of "Buy America"

The Buy America provisions in the House stimulus bill were bad enough. The Senate version threatens to make them even worse, extending them from government purchases of steel to government purchases of all manufactures. These measures are possibly illegal in international law, flatly contradict a commitment that the US made at the G20 summit in November, and (most important) are likely to hurt the economy more than help it. Is this the new spirit of US multilateralism? Smoot Hawley, anyone?

Read the analysis by Gary Hufbauer and Jeff Schott of the Peterson Institute.

Based on economic and legal analysis, the authors conclude that the Buy American provisions would violate US trade obligations and damage the United States' reputation, with very little impact on US jobs. They estimate that the additional US steel production fostered by the Buy American provisions will amount to around 0.5 million metric tons. This in turn translates into a gain in steel industry employment equal to roughly 1,000 jobs. The job impact is small because steel is very capital intensive. In the giant US economy, with a labor force of roughly 140 million people, 1,000 jobs more or less is a rounding error. On balance the Buy American provisions could well cost jobs if other countries emulate US policies or retaliate against them. Most importantly, the Buy American provisions contradict the G-20 commitment not to implement new protectionist measures--a commitment that was designed to forestall a rush of "beggar-thy-neighbor" policies.

What should be done? The best result would be to simply delete the Buy American provision in the House-Senate conference. Next best would be to keep the House version, applying the Buy American restriction only to iron and steel, but stating explicitly--in either the statutory text or in the legislative history--that the public interest waiver is intended to be used to avoid violations of US trade obligations. The third option is a presidential statement--preferably before legislation is finalized--that the United States will respect its international obligations when it applies the Buy American provisions.

Tom Daschle steps down

The withdrawal of Tom Daschle's nomination to head Health and Human Services is a serious setback. This was an Obama appointment I had liked very much, because Daschle untypically combines real expertise on health policy with years of Congressional experience. I had also liked the way Obama had named him top White House adviser on health as well as head of the lead agency--thus avoiding the problem of overlapping or ambiguous authority that one sees developing in economic and foreign policy. Daschle, it seemed to me, was the very man to get things done. Perhaps he is out altogether; perhaps he will be retained as an adviser, and will have to work with whoever gets the job he wanted. In either case, not good.

The New York Times's hard line may have had something to do with it. The paper had also rounded on Tim Geithner, as you may recall, but in that case did not explicitly call for the nominee to be ditched.

Another unhelpful development, from Daschle's point of view: this morning Nancy Killefer withdrew as a candidate for a top job at OMB and "chief performance officer" for the administration--citing tax issues concerning her domestic help. (She is a finance expert who had led an effort to modernise the IRS in the Clinton administration. Subsequently, as a member of the IRS oversight board, she called for more to be spent on bringing cases against high-income tax cheats.) One oddity here is that her seemingly trivial tax issue has been public for weeks. Perhaps there was more.

The problems of Democrats and their difficulty over paying taxes have become the most memorable theme of this transition. The jokes write themselves and much of the derision is well-deserved. But I'm dismayed by Daschle's downfall.

Bad politics and urgent remedies

My Monday column for the FT is a plea for rapid action on the stimulus.

You could not call the fiscal stimulus passed by the US House of Representatives last week, without a single Republican vote, a beautiful piece of legislation.

With luck it will be improved over the next few weeks. But if you believe, as I do, that a big stimulus is needed, a measure of this sort, however unlovely, is far safer than the likeliest alternative - which is further protracted delay.

While Washington quarrels about the details in this absurdly complex proposal - it runs to more than 600 pages - the recession worsens.

Politicians seem unaware. Jobs are evaporating, the housing market continues to deteriorate, a fresh and even larger wave of mortgage foreclosures may be approaching, the financial system is prostrate. Meanwhile, Democrats dream their dreams about reinventing America and Republicans recite their anti-government catechism.

You can read the rest here.