As you can see, M2 has been growing at a reasonably steady rate for the past 15 years.  BASE made up a reasonably constant proportion of M2 up until the end of 2008.  At that point the Fed had to dramatically increase the BASE money supply in order to keep M2 expanding at roughly the accustomed rate.

There are a number of different ways of looking at this.  It could be that this is simply the new normal and the the Fed’s balance sheet will henceforth make up a higher percentage of the overall money supply than has generally been the case.

Alternatively, you could view the situation as essentially benign.  The Fed’s balance sheet is relatively large because it had to respond to the crisis.  It will shrink over time as the economy recovers.  My guess is that this is Chairman Bernanke’s preferred assessment.

The pessimists among us tend to believe that quantitative easings are a bit like wars in the Middle East.  Much easier to get into than out of.

I’m inclined towards pessimism, or at least skepticism about the existence of free lunches.  The Fed’s extraordinary actions over the past few years may well have taken some of the bite out of the crisis, but my guess is that we pay for them through either inflation or uncomfortably tight monetary policy down the road.

(Data source:  St Louis Federal Reserve)

This was entirely predictable, but very disheartening for those of us who would like to see the deficit reduced mainly through expenditure control.  What Republicans have apparently failed to grasp is that time is not on the side of fiscal conservatives.  As this insightful article points out, the longer we wait the more inevitable tax increases become:

To understand the stakes facing fiscal conservatives, one must appreciate how demographics, program indexing methods and political realities combine to stack the deck against them. By bipartisan consensus, we won’t cut the benefits of those already in retirement; we won’t send a $2000 check to an 85-year-old widow in January and then cut it back to $1600 in February. Both parties (including the most conservative members) repeatedly reaffirm their dedication to this principle.

As a result, with each new class of retirees there is a new set of politically inviolate benefit obligations. Moreover, due to the wage-indexation of the initial benefit formula, the minimum threshold of politically acceptable future benefits rises with each subsequent class of retirees. So, with each year of delay the share of the problem eventually solved by tax increases inevitably rises.*

Well before 2037, unless we cut benefits for those already retired, a tax increase could not be avoided even if the entirety of payments to new beneficiaries were shut off. Thus, if action is delayed for several years, virtually all of the “solution” will consist of tax increases.

Our potential success in constraining the growth of taxpayer burdens therefore depends largely on when a solution is enacted. It is not so simple as deciding a particular solution is faulty, tearing it up, and trying again in a few years on the hope that conservatives’ political position will then be stronger. Such a strategy naively ignores demographic realities. Enacting Simpson-Bowles by contrast would allow conservatives to lock in constraints upon cost growth that simply will not be achievable under a delayed solution.

Republicans may not actually be serious about deficit reduction.  Or they may be calculating that they will be able to negotiate a better deal next year.

If the latter is true they are making a serious gamble.  The election largely wiped out Democratic moderates.  The Democrats who remain are likely to be more committed to closing the fiscal gap with new taxes, and very much aware that they only need to stall in order to get their way.

The Republicans have the opportunity right now to shape the deficit debate by endorsing some variant of the ‘bi-partisan’ Simpson-Bowles plan.  If they instead try and push a Republican plan next year the chances of getting a deal drop to near zero.  Unfortunately for the country, failure to get a deal is effectively the same as voting for higher taxes.

* Reference to a chart showing projected increase in Social Security beneficiaries has been omitted from the quote

Cash for Clunkers moved a bunch of auto sales forward, causing people who thought they might replace their car in the next year or two to rush into the showrooms.

This is a true but incomplete explanation.  The Cash for Clunkers sales likely came from several sources:

1. Once the program was announced many buyers likely postponed purchases until they could take advantage of the subsidy.  So sales in the period immediately prior to the start of the program were artificially lowered.
2. As Megan points out, people who intended to buy a car in the next year or so likely brought forward their purchase in order to take advantage of the subsidy.  So sales in the period after the end of the program were (and will continue to be) artificially low.
3. People who were weighing up possible purchases opted to buy a car, as opposed to say new appliances or a trip to Disneyland, in order to take advantage of the subsidy.  So higher car sales were balanced in part by lower sales in other parts of the economy.
4. People who might otherwise have saved or paid down debt opted to purchase a car in order to take advantage of the subsidy.

Sales resulting from explanations 1 and 2 were simply a direct wealth transfer from future taxpayers to car buyers.   There wasn’t any real impact on the number of cars sold, just the timing, so the car companies aren’t really better off.  Any stimulative effect on economy would be the result of car buyers choosing to spend rather than save their subsidy windfall.

By contrast, sales resulting from explanation 3 were rather more insidious.  In addition, to the wealth transfer from future taxpayers to car buyers these sales also include a wealth transfer from non-car companies to their automotive brethren.  In other words, politically favored companies got some increased sales at the expense of those with less political pull.

Overall, these sales don’t represent any increase in aggregate demand.  Again, any stimulative effect on economy would be the result of car buyers choosing to spend rather than save their subsidy windfall.

The subset of sales driven by explanation 4 was the most economically useful.  Additional cars sold without an offsetting loss of sales in other parts of the economy actually represent an increase in aggregate demand.

So the utility of the program as a Keynesian stimulus depends on the proportion of sales driven by explanation 4 and the extent to which the windfalls enjoyed by car buyers driven by explanations 1, 2 and 3 were spent rather than saved.  It is possible, even likely, that the effective stimulus was substantially less than the $3 billion plus the program cost.

Taking a broader view, this program suffers from the same problem that dogs most stimulus initiatives.  A small fraction of the economy will experience direct benefits.  The remainder of the economy will simply see future costs in the form of higher taxes, interest rates and inflation, and a more politicized economy.   For this reason, stimulus efforts that aren’t linked to future productivity improvements are, at best, a questionable idea.

If I had to pick an animal to describe the US economy right now I’d have to go with the hamster.  But like a really tired hamster that has been running around its cage for like seven years.  Right now it’s exhausted.

As a micro-economist I would say that the hamster needs some rest.  Macro-economists, of course, look at the hamster and think that it needs some methamphetamines.

Now, I’m sure that they are right.  Over the past month I’ve learned that the three most terrifying words in the English language are, “macro-economists agree that”.

I’m sure they are right about the hamster needing methamphetamines.  But all I’m saying is that in two years that is going to be one ugly hamster.

The split over the entire period from 2012 to 2050 is 53.4% for consumers and public purposes, and 20.1% for private industry.

Assuming you believe Mr Thoma’s math, Waxman-Markey is actually a massive giveaway to consumers, special interests and private industry.  This is not exactly a compelling defense.

The problem with the bill is not the manner in which the giveaways are divided.  It’s the existence of giveaways.

The whole point of a cap and trade system is to price carbon emissions and thus incorporate the cost of CO2 emissions into the price of everything those emissions produce. Price signals can then drive innovation to minimize the carbon use and ensure that maximum economic benefit comes from the level of emission we believe is acceptable.   If carbon permits are given away, regardless of who exactly the giveaways are intended to benefit, this price mechanism is undermined.

The fundamental problem here is that American public would apparently like to believe that the transition to a low carbon economy can somehow be achieved without carbon based energy becoming significantly more expensive.   Unfortunately, there is no free lunch to be had here.  A major restructuring of the US economy isn’t going to occur unless the financial incentives surrounding energy use are significantly realigned.

What Congress should have done is create a fully auctioned cap and trade system, then used the resulting revenue to lower and simplify income taxes.  This would have shifted the burden of taxation from a earned income (generally considered a social positive) to a negative externality without increasing the overall tax burden on the economy.  Energy would get more expensive while labor gets cheaper.  It would also likely have created a broad base of political support for cap and trade.

Tragically, this is not what happened.  The administration, somewhat naively, expected their fully auctioned program to become a new and fruitful source of revenue to fund its ambitious spending plans.  When this proved politically unfeasible, the congressional leadership was allowed to use carbon credits giveaways to buy off opposition to the bill.  In its desperation to achieve legislative success, congress has not flinched at undermining the bill’s original objectives.  The revised bill is more politically palatable in that it apparently won’t really affect energy costs.  Of course, if energy costs aren’t affected there is very little chance the thing will actually work.

It is revealing that Congress choose to lard the bill with energy use regulations.  If the bill were going to effectively price CO2 emissions the regulations would be redundant.  Market forces would drive change without the need for mandates from Washington.  Clearly, even Congress doesn’t really believe that the cap and trade portion of the bill will drive change.

To be fair, the successful SO2 cap and trade scheme, on which the bill is based, gave away rather than auctioned SO2 emission rights.  The prospect of selling surplus SO2 credits, or the threat of having to buy extra credits, encouraged enough companies to find ways to limit SO2 output.  So Waxman-Markey may not be completely hopeless.

However, SO2 was a relatively minor problem that could be minimized without a wholesale restructuring of the US economy.  It is extremely difficult to believe that a similarly low key approach will yield the changes required to move us towards a low carbon economy.  For those of us who believe in harnessing the power of markets to solve environmental issues Waxman-Markey is a profound disappointment.

1. The bond market is deeply pessimistic about the economy, meaning that deflation is a possible concern and holding 30 year government bonds with a 4.5% yield is actually quite attractive.
2. The bond market is very optimistic (snicker) about both the Fed’s ability to shrink its balance sheet  and government’s ability to bring the fiscal deficit under control when the economy improves, meaning that inflation is not a threat.
3. Global imbalances  have become, to an extent, self perpetuating.

The third explanation arises from an old, informal rule of banking, “If you owe a $100 the bank owns you.  If you owe a $100m you own the bank”.  My thinking here is that the United States has become a debtor that is too important to be denied credit.

Due to years of conscientious currency manipulation China (and other trade surplus nations) have accumulated enormous dollar assets.  Protecting the value of these assets is not an insignificant concern.  This means that US interest rates cannot be allowed to go up in any situation where the rise would not be accompanied by an offsetting rise in the dollar.

The 30 year bond auction was just such a situation.  A poor auction would have resulted in higher long term interest rates.  Normally higher rates would put upward pressure on the dollar.  However, right now, a bad auction would imply that the government is going to have difficulty funding the deficit, increasing the likelihood that the deficit will be monetized, which would be bad for the dollar.

So a bad auction would likely mean US interest rates up and the US dollar down, which is the worst possible combination if you happen to be a foreign power that owns a lot of dollar assets.

If you were such a power my guess is that ensuring a strong auction, by say bidding for a bunch of bonds, would start to look like a good idea.  Interestingly, indirect bidding (i.e. by foreign central banks) during the Treasury auction was described as “strong”.

On Monday, Florida coach Urban Meyer agreed to a six-year contract that will pay him $4 million a year. Earlier this year, the Alabama state university system’s trustees approved earlier a $80.6 million project that will expand Alabama’s Bryant-Denny Stadium to accommodate more than 101,000 fans. Meanwhile, on the other end of the Football Bowl Subdivision food chain, Hawaii athletic director Jim Donovan last week took a voluntary seven percent pay cut to help offset a projected $2.6 million deficit for the 2008-09 fiscal year.

I’m actually a little skeptical of this argument.  College football royalty like Florida already get the best coaches, the best facilities and (most importantly) its choice of the best players.  So it is far from certain that an increased budget will generate any better results.  Will Urban Meyer be a better football coach because his salary went up by $750K per year?

Like most human endeavors, college football is subject to diminishing returns.  Beyond a certain point adding resources to a football program like Florida’s is really just padding costs.  Where the increasing big school revenue advantage is likely to pay off is the non-revenue sports.  The excess revenue generated by the football and basketball programs can buy those big money schools a lot of wins in soccer, tennis, track and swimming.

What happened to the dream?  Government mismanagement, yes, but something more than that, too, some failure of imagination and will.

There are a couple of problems with this sentiment.  Foremost is the fundamental misunderstanding of what the Apollo program was really all about.  The United States didn’t go to the moon because of some insatiable human desire to “boldly go where no man has gone before”.  That is retrospective romanticism.

The United States really went to the moon out of fear.  Specifically the fear of Soviet domination of space.  President Kennedy launched the Apollo project based on the advice of NASA deputy director Hugh Dryden’s advice that a lunar landing was a sufficiently long term goal that NASA would have a chance to catch up with the Soviet’s technological lead and actually get there first*.

By the time Neil Armstrong made his famous footprint, the fear of  Soviet owned space had been thoroughly dispelled, and with it the driving force for human space exploration was lost.

There are many legitimate reasons to criticize NASA’s activities since the end of the Apollo program.  However, exploring the rest of the moon, or putting a man on Mars, were not realistically achievable goals.  The moon landing was a crash program put together in response to a perceived national emergency.  That level of effort was simply not sustainable indefinitely.  Adventurous spirit and scientific curiosity have never been enough to get political support for the kind of expenditures required to take further leaps into deep space.

It thus isn’t really accurate to call the lack of progress since 1969 a failure of imagination and will.  The last forty years have reflected the normal, frustratingly erratic,  progression of most human endeavors.  The 1960′s was the aberration.

My other issue is with the, “What happened to the dream?” question.  The idea seems to be that, in the absence of leadership from Washington, humanity’s future in space has been put on indefinite hold.

In truth, the dream is in very rude health.  The last decade has seen the birth of space tourism, the first private space flights and a burst of entrepreneurial enthusiasm.   If you really care about space exploration you would do well to keep an eye on the development of the private sector rather than NASA press releases.  If there is an economic return to be generated from commercial activities in space people will go there, even without government help.

We may very well see NASA astronauts back on the moon.  NASA planing says ‘yes’, a realistic assessment of the federal budget outlook says ‘not likely’.  Even if NASA never makes it back I’m pretty sure somebody will.  What’s more, we may all have the opportunity to participate, not by paying taxes, but by buying stock.

As an aside, we could pay $100-$150 billion (optimistically) for NASA to put a base on the moon sometime after 2020, or we could put aside say $50 billion as a kind of super X prize to be awarded to the first organization to sustain a human presence there for 12 months.  I know which alternative makes more fiscal sense for our cash strapped government.

* There are many non-fiction accounts of the 60′s space program.  However, perhaps the best way to capture the feeling of the time is to read Tom Wolfe’s famous novel The Right Stuff.  Or you can check out his recent Op Ed piece in the New York Times

The more alarming chart is taken from Nancy Pelosi’s office wall:

A naive observer might conclude that the current recession is the worst since WWII.  Unfortunately this chart doesn’t adjust for the dramatic overall expansion of the labor force over the last fifty odd years.  William J. Polley has produced a more informative (less ludicrously tendencious) percentage based comparison.  Note that the current recession actually falls somewhere in the middle of the pack for post WWII recessions.

The second chart is an annotated copy of the Time Magazine original.

There is nothing actually wrong with the chart.  However, the annotations are interesting.  Mr DeLong has added the names of the Presidents who happened to be in office during the charted recessions.  It isn’t clear what Mr DeLong’s purpose in doing this was exactly.  Perhaps Mr DeLong is trying to suggest responsibility.  If so, he appears to have made the classic mistake of confusing correlation with causation.

The other questionable addition is the gratuitous highlighting of the current recession.  Painting something bright red and labelling it with a honking a great sign is not exactly the strategy of someone seeking to make a sober analysis.  Perhaps the real purpose of this overdone annotation is to conceal the fact that, when charted in relative terms, the trajectory of employment in the current recession looks a lot like that of the 1981 recession.  While certainly very unpleasant, the 1981 recession did not in fact result in the end of civilization, which is not the kind of thing you want to dwell on if you are trying to sell people on your, “the world is going to end if Congress doesn’t spend” view of the world.

“That is why — despite the risks — I support a large stimulus. The United States debt levels suggest that it still has room to use the public sector’s balance sheet to try smooth the economic cycle. And there is nothing moderate about the current cycle.”

‘Things are really bad, we should try something, even if its very risky’, isn’t exactly a ringing endorsement of fiscal stimulus as a response to the current crisis.  In fact, it reveals the biggest problem with fiscal stimulus.  While the costs are large and certain, the supposed benefits aren’t exactly guaranteed.

In situations like this it is often helpful to lay out the options and their consequences in the form of a decision tree:

Stimulus Decision Tree

In this case X is certainly less than one.  It may in fact be significantly less than one.

At the very least, this should give us pause before endorsing stimulus as a policy response.  It is always worth remembering that there is no situation so bad that Congress can’t make it worse.