The American Spectator

The Public Policy

Last Friday night was the coldest night in Washington, D.C. in ten years, according to the man on the radio. Blessedly, my wife and I spent the evening transported by the National Symphony Orchestra's performance of Rachmaninoff's Piano Concerto No. 3 in D minor, Opus 30, in the lush surroundings of the Kennedy Center's Concert Hall.

The pianist was a young Norwegian, Lief Ove Andsnes, who drew a standing ovation and took three encore bows. EMI Classics will release his new CD this spring.

Damn! I would sooner give up my house than part with our symphony tickets. Music is truly a balm for the soul, especially in such difficult times as these. The daily papers and news broadcasts are unrelievedly depressing. Our financial and political elites really do not know the length, breadth, or depth of the current economic crisis that their kind has visited upon the county. Nor do they understand how to remedy the situation. They are making it up as they go along.

How else do you explain Bank of America taking on a turkey like Merrill Lynch, then declaring tremendous losses for the last quarter of 2008?

The stockholders are understandably peeved that they did not know about the sorry state of affairs before the takeover. Management tries to justify itself as taking a bullet for the nation, but it is hard to square that with the fiduciary interest owed to stockholders. Of course, the Bank is receiving more federal bailout dollars to cover heavy losses in its new subsidiary.

I have no problem with elites, per se, as long as they get the job done. But our current crop appears to be a pretty feckless bunch. Please understand that I am not making a partisan criticism here. Whether it is Wall Street or Washington, the character and intellectual deformities afflict Republicans and Democrats alike.

One must take small pleasures where one can find them. The previous weekend I had to spend all of the Lord's Day, January 11, flying across the country on a business trip. A small but delightful compensation for such an inconvenience is the ability to read every single page of the Sunday New York Times, cover to cover, given the plentiful time spent aloft and in airports.

I was rewarded with a perceptive article  by N. Gregory Mankiw, a Harvard economics professor and a former advisor to President Bush: "Is Government Spending Too Easy an Answer?" -- in the New York Times of all places!

The good Professor musters the courage to question the Keynesian demand-side assumptions of the incoming Obama administration, promoted in college classrooms for decades through the classic textbook, Economics, written by Paul Samuelson and first published in 1948. In fact, says Professor Mankiw, Lawrence H. Summers, a very sharp fellow and the new head of the National Economic Council, is Mr. Samuelson's nephew.

Mankiw notes that the new administration, not to mention most of Congress, believes the centerpiece of any economic recovery must be "a huge increase in government spending." That said, "there are ample reasons to doubt whether this is what the economy needs."

One reason for doubt is a study by Valerie A. Ramey, an economist at the University of California, San Diego, which reviewed U.S. history and concluded that each dollar of government spending increases GDP by only 1.4 dollars. "When G.D.P. expands, less than a third of the increase takes the form of private consumption and investment," argues Mankiw.

Later in his article, Professor Mankiw cites another study, by Christina D. Romer and David H. Romer, formerly economists at University of California, Berkeley. Readers may recall that Christina Romer is in line to become President Obama's chairwoman of the Council of Economic Advisers, a very fortunate development as will become clear in a moment.

The Romers' research revealed that a dollar of tax cuts raises GDP by roughly $3!

"According to the Romers, the multiplier for tax cuts is more than twice what Professor Ramey finds for spending increases," says Mankiw.

Mankiw speculates, reasonably, that Christina Romer's participation in the Obama economic team may explain the recent increase in tax cuts as part of the new administration's stimulus package.

Professor Mankiw does not tell us what kind of tax cuts deliver the most robust multiplier effects, but traditional supply-side theory would point to cuts in marginal income tax rates and corporate and capital gains taxes as optimal because they are what truly drives entrepreneurship. Moreover, these kinds of tax cuts should be permanent so as to encourage long-term investment, risk-taking and job creation.

The Obama administration is probably not going this far, but neither is the Republican congressional leadership articulating the case for doing so. This might be an opportunity for useful engagement, even debate. There will be much more spending, some of which is needed and justified. Still, the Obama team seems to be open to the arguments for tax cutting. This may be one of those rare moments when the public dialogue can generate something more than mere posturing or pandering to established constituent blocks.

If we are operating in fundamental ignorance of the complexity of an economy debauched by questionable securities, lending and investment practices, we need to take a portfolio approach to managing the risks of this recession and deploy both supply-side and demand-side policy tools.

topics:
Financial Crisis, Sergei Rachmaninoff, Paul Samuelson, N. Gregory Mankiw