Saturday, February 14, 2009

From the department of WTF? Should We Be Worried About Too Much Debt?

Harvard's Jeff Frankel asks, "Is $800 billion too big or too small?" and answers "Yes". In other words, he thinks it's too big and too small. Too small in the sense that it's not big enough to fill the output gap, too big in the sense it adds too much to the deficit.

A couple of points: Frankel uses a smaller output gap that I think is reasonable to predict, and he neglects considering state and local budget cuts, so while he agrees that $800 billion is too little to plug the output gap, he massively understates the extent to which the Obama stimulus is insufficient. More importantly, if what he is saying is correct, and investors are starting to get weary about holding more greenbacks, then we should see the dollar sliding against currencies, such as the Euro, who have smaller stimulus packages. Indeed, I believe this was Summers' reasoning.

But check this out:

The dollar has actually increased substantially vs. the Euro! Now, it only takes $1.28 to buy one Euro, vs. $1.56 last summer, and $1.36 early last December. It doesn't seem to be taking much of a hit. And, last week, the dollar was unchanged vs. the yen, and on Friday, when the stimulus passed the Senate, the dollar actually rose against the yen. Indeed, even though the housing crisis and the banking crisis originated in the US, the dollar has strengthened against virtually every other currency since the crisis started. In turn, this has hurt the competitiveness of US producers and manufacturers, and is part of why we are bleeding jobs.

Let's think about it: if you were Toyota, and you were trying to decide which factory to close, would you close the factory in Canada, when the Canadian dollar has just depreciated 20% vs. the US dollar, cheapening labor costs? Or would you close your Mexican plant, given that the Mexican Peso has depreciated 40% vs. dollar, reducing labor costs there? (I'm not sure Toyota is even in Mexico, but several automakers are there, and they have to decide the same thing.) My bet is that you would close your American factory, since wages haven't fallen nearly as much as the dollar has appreciated.

So, on one hand, given the strengthening dollar, Frenkel's worry about debt appears unfounded. Secondly, Frenkel is wrong that if the dollar did weaken over concerns about the debt, that the resulting increase in competitiveness would somehow be a bad thing. Perhaps Frenkel is correct that if the stimulus had been on the order of $1.5 trillion, which is twice as big as it actually was and is roughly what I would have proposed, it would be better to include some future tax increases on the rich in the proposal, just to allay these long-term debt fears.

Still, I gotta ask: What's the Matter with Harvard Econ? Between Summers, Feldstein, Barro, Mankiw, Shleifer, and Frenkel (plus Baldwin), Harvard Econ looks like a nut-house. Rodrik has not impressed as of late either. Why does it seem like they've all got shit for brains? (Hoping to get someone from the H to take the bait and respond here...)

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