Tuesday, June 5, 2012

Professor Taylor's Completely Misguided Reagan Comparison

Once again, professor Taylor is talking with admiration and love of the Reagan recovery.  In his latest blog post, he writes about a memo to Reagan written a few weeks before he took office.  However, Professor Taylor's statement that Reagan's policies -- if implemented -- would solve our current economic situation is completely misinformed.  First, as I've pointed out, we're in the middle of a debt deflation recovery.  The policies to extract ourselves from this problem are far different than the Reagan slump.

More to the point, here is the central problem with Taylor's analysis, beautifully written:

The world of 1980 had tons of pent-up demand and gale-force tailwinds. Inflation and interest rates were coming down from high levels, household leverage was very, very low, financial innovation non-existent, consumption had been deferred, and demography was coiled as the baby boomers were just coming on line. On the government side, unions were powerful, price and wage controls were a reality, and tax rates were high. This was the ideal set up for supply side reforms.

Fast-forward to post-2008. Whatever the opposite of pent-up demand is, that’s what we have. Inflation and interest rates are already low, household leverage is a major burden, consumption was pulled forward during the boom, and demography is no longer our friend. Plus, we have globalization acting like a supply shock to our labor pool, holding down wages. In short, the tailwinds are now headwinds. On the government side, unions are far less powerful today, there are no price and wage controls, and tax rates are low. It seems next to impossible to make the case that supply-side policies can have anywhere near the effect today that they had in the 80s.

As the title to the above referenced article states, "Reagan's dead, you're old, get over it."  The continual pining for the age of Reagan has become a  fetish on the right (which typically conveniently forgets his extensive fiscal recklessness), as they long for a presidency and time that is over and with which we have nothing in common economically.

Consider the following points:

Taxes are already low; cutting them more from this level will have little to no impact on economic activity -- but will blow a bigger hole in the deficit.  Compare especially the the personal tax rate in late 1970s to today; in the 1970s it was around 9% of GDP and climbing; now it's around 7%..  And corporate rates -- which have always been low, are now near the lowest they've been in the last 40 years.

And then there is the fact that marginal rates are far lower today (39.6% v. 70% when Reagan took office).  And while the US corporate tax rate is 35%, there are more holes than Swiss Cheese in the corporate code allowing corporations to pay little to no tax in most situations (and that's assuming the company uses the corporate structure rather than a pass through structure: most don't).   

And then there is this:

Under Reagan, interest rates were at their highest level in nearly 50 years.  When you lower rates from 17.5% to a 8%, you're going to simulate growth.  Now, we're at the lowest level we can get.

The political right has been preaching the same policy prescription for the last 40 years: lower regulation and lower taxes.  While that solution did help to contribute to Reagan's economic success, an excessive amount of both got us into the current situation: a complete laissez-faire attitude toward regulation led to a financial sector making all sorts of stupid loans that started the housing bubble and the continual cutting of taxes without the requisite cutting in spending started the budget mess (Bush tax cuts + Iraq war + Medicare Part D == massive budget hole).  

Our current economic problem can best be defined as a liquidity trap:
The Liquidity trap is a Keynesian idea. When expected returns from investments in securities or real plant and equipment are low, investment falls, a recession begins, and cash holdings in banks rise. People and businesses then continue to hold cash because they expect spending and investment to be low. This is a self-fulfilling trap.
Consider these charts:

We have a ton of money available to lend.  But we're not lending it:

Banks aren't lending at nearly the rate they could be right now.  That means interest rates will stay low (excess supply = lower cost).

Another reason we have the increased savings is people aren't spending at anywhere near the same pace:

Transactions are moving at a glacial pace -- and getting slower not faster.

Professor Taylor is a darling of the WSJ editorial page.  In saying that, we know before he even writes a word what he's going to say and advocate for.  But the available data completely contradicts his statements and beliefs regarding the economy.   As I've previously written, the "policy uncertainty" argument doesn't hold up to even a surface evaluation, let alone an in-depth analysis.  And I have yet to see his reasoning on why this isn't a debt deflation bubble, especially when all the pieces of the theory clearly line up.

To re-state the title of Mr. Dow's article: Reagan is dead.  He and Clinton had the benefit of rising the wave of baby boomers as they hit their peak earning years.   All either had to do was get out of the way -- which both did.  However, we're dealing with a completely different population and economic situation now for which the standard supply side ideas offer no new ideas -- and, in fact, would greatly exacerbate the current fiscal situation.