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Karim writes:

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>   
>   (email exchange)
>   
>   On Tue, Sep 29, 2009 at 11:20 AM, Joshua Davis wrote:
>   
>   moving in the right direction for sure, but for partly
>   the wrong reason…he still misses the point that we’re
>   not on a gold standard…
>   

Yes, very much so. Does not seem like it would take much to set him straight.

If anyone on this list knows him, please email him a copy of ‘the 7 deadly frauds’ thanks!

The true fiscal cost of stimulus

By Paul Krugman

Sept. 29 (NYT Blog) — As I get ready for the CAP and EPI events, I’ve been thinking more about the issue of crowding in. (See also Mark Thoma.) And I’m coming more and more to the conclusion that the public debate over fiscal stimulus, which views it as an agonizing tradeoff between possible benefits now and certain costs later, is wildly off base.

Just to be clear, we’re talking about fiscal stimulus in a liquidity trap — that is, under conditions in which conventional monetary policy has lost traction, in which the Fed would set interest rates much lower if it could. Under more normal conditions the conventional view of stimulus is more or less right. But we’re in liquidity-trap conditions now, and will be for a long time if official projections are at all right. So what does that imply?

First of all, as I and others have pointed out, fiscal expansion does not crowd out private investment — on the contrary, there’s crowding in, because a stronger economy leads to more investment. So fiscal expansion increases future potential, rather than reducing it.

And yes, there’s some evidence to that effect beyond the procyclical behavior of investment. The new IMF analysis of medium-term effects of financial crisis finds that

    the evidence suggests that economies that apply countercyclical
    fiscal and monetary stimulus in the short run to cushion the
    downturn after a crisis tend to have smaller output losses over
    the medium run.

So fiscal expansion is good for future growth. Still, it does burden the government with higher debt, requiring higher taxes or some other sacrifice in the future. Or does it? Well, probably — but not nearly as much as generally assumed.

Here’s why: first, in the short run fiscal expansion leads to higher GDP, which leads to higher revenues, which offset a significant fraction of the initial outlay. A billion dollars in stimulus probably leads to only $600 million or a bit more in additional debt.

But that’s not the whole story. Crowding in raises future GDP — which raises future tax revenues. And the rise in revenues relative to what they would have been otherwise offsets at least some of the burden of debt service.

I’m not proposing a fiscal-stimulus Laffer curve here: it’s probably not true that spending money actually improves the government’s long-run fiscal position (although that’s certainly within the range of possibilities.) What I am suggesting is that fiscal stimulus under current conditions, where theFed funds rate “ought” to be around -5 percent, does much, much less to hurt that long-run position than the headline number would suggest.

And that, in turn, means that penny-pinching on stimulus is deeply, destructively foolish.

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Regarding FDIC fees, the smaller the better, so nice to seem them sort of moving in that direction.

All they do is raise rates as they raise the common cost of funds for banks, and Fed policy is to lower rates.

Be nice to have leadership that understands banking and the monetary system!

From: MICHAEL CLOHERTY

Details on the proposal still rolling in. Two immediate takeaways:
less acute quarter-end dislocations, and definitional problems in LIBOR
likely to remain. There will be no more special assessments– those
assessments were based off of quarter end levels of assets, so banks had
a very strong incentive to squeeze quarter end balance sheets. Regular
fees are based off of quarterly average levels of insured deposits, so
you won’t get the same degree of quarter end window dressing (which
means smaller market dislocations).

In addition, they are talking about relatively moderate increases in
future FDIC fees– a 3bp increase in 2011. Fees will be lower than the
23bps hit after the S&L crisis. That means there will be less of a
shift toward uninsured deposits (overseas deposits) in order to avoid
that fee. Which means activity in eurodollar deposits remains light, so
there is no good benchmark for LIBOR (banks are likely to continue to
look at CP/CD rates when submitting their settings).

There will be a near-term increase in bank financing needs, as banks
need to come up with $45bn to prepay fees. This may create a small
hiccup in the downward trend in CP, as well as some additional bank
issuance in the 2yr to 3yr sector.

Also, a small decline in bill supply over year end– the FDIC will take
the $45bn and buy “nonmarketable treasuries” with it (the same IOUs that
are in the social security trust fund). The Tsy will take the $45bn of
cash and spend it, so they dont need to issue quite as many bills as
they otherwise would have. Note that the payments are due Dec 30.

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