Sugar, or the Changing Nature of “Confidence” in the Administration’s Economic Policy

Oh dear god.  Sorry to start with two long block-quotes, but they are important and upsetting.  Zachary Goldfarb, Washington Post, Geithner Finds His Footing:

Lawrence Summers, then the director of the National Economic Council, and Christina Romer, then the chairwoman of the Council of Economic Advisers, argued that Obama should focus on bringing down the stubbornly high unemployment rate. This was not the time to concentrate on deficits, they said.

Peter Orszag, Obama’s budget director, wanted the president to start proposing ways to bring spending in line with tax revenue.

Although Geithner was not as outspoken, he agreed with Orszag on the need to begin reining in the debt, according to current and former administration officials…
The economic team went round and round. Geithner would hold his views close, but occasionally he would get frustrated. Once, as Romer pressed for more stimulus spending, Geithner snapped. Stimulus, he told Romer, was “sugar,” and its effect was fleeting. The administration, he urged, needed to focus on long-term economic growth, and the first step was reining in the debt.

Wrong, Romer snapped back. Stimulus is an “antibiotic” for a sick economy, she told Geithner. “It’s not giving a child a lollipop.”

In the end, Obama signed into law only a relatively modest $13 billion jobs program, much less than what was favored by Romer and many other economists in the administration.

“There was this move to exit fiscal stimulus a lot sooner than we should have, and we’ve been playing catch-up ever since,” Romer said in an interview.

Ryan Avent event goes to a meeting of administration economic policy advisors and leaves completely confused about the idea of “confidence” and has a must-read post on it, Feeling Confident?:

I asked [Goolsbee] whether his comments could be taken as indicating that the administration no longer felt fiscal stimulus could or should be used to support aggregate demand. Not at all, he replied, before talking more about the investment incentives and regulatory initiatives the White House has supported. These were, almost exclusively, supply-side policies. The administration’s business-support efforts look like useful steps to me, but they’re clearly not designed to provide a direct boost to aggregate demand…

The comments from Gene Sperling, Director of the National Economic Council and a key member of the team negotiating an agreement on an increase in the debt ceiling, were clearer still. The White House believes, he said, that deficit-cutting is an important component (the emphasis was his) of a growth strategy. And he repeatedly said that deficit-reduction was crucial in generating economic confidence. Confidence—he repeated this word many times….

At the same time, he said it is plain that a deal with the Republicans will involve a “bipartisan downpayment”. There will be short-term cuts, despite warnings from Ben Bernanke, Christina Romer, and many others.

I struggle to understand the logic. Britain counted on “confidence” to lift the economy amid austerity and has been sorely disappointed, despite an accommodative central bank. The literature on expansionary austerity suggests that it’s not an impossibility, but that it nearly always occurs in countries where high debt levels have produced high interest rates. America simply can’t benefit from the interest rate impact of austerity; its interest rates have nowhere to go but up.

So there appears to be a key switch sometime in the past 18 months in what is motivating neoliberals to address the long-term deficit and in the work that “confidence” needs to do, and I think Geithner’s rise in the administration can help explain it.

Two Deficits

I try to keep up with the various conceptual apparatuses different political agents use to understand what is wrong with the economy and how to get it to work better. In the neoliberal space there tends to be a “two deficits” debate – we need a much larger short-term deficit while we also bring down the long-term deficit.

Now why do we have to worry about the second, long-term deficit in the “two deficits” scenario?  My understanding of the neoliberal landscape was that it was to convince the bond market that further stimulus would be temporary, thus allowing a larger short-term stimulus to drive down unemployment without freaking out the bond market.

Noam Schieber had a great New Republic article explaining the “two deficits” debate in the administration from December 2009, noting: “Take, for example, the fact that spending more money now could actually raise long-term rates, thereby offsetting its stimulative effect. ‘The reality is that it’s not too hard to find a Wall Street analyst that says a second stimulus basically cancels itself out almost immediately because of the impact at this stage on government financing costs,’ says one senior administration official. On paper, the way to deal with this is to spend now while pledging to cut later on, so as to persuade the bond market that the infusion is temporary.”

Neoliberals, as far as I understood them, care about reforming the long-term deficits not as an end in-and-of-themselves, regardless of the waste and potential for more optimal spending, but as a means to increase a short-term stimulus without panicing the markets.  You can doubt that a second stimulus would panic the bond market (I do), but the logic makes sense.

These two articles above, particularly Avent’s, show that there was a transition, where the long-term deficit reduction has becomes its own goal.

This New Approach

Notice the change in what the concept of “confidence” is doing in each.  The idea of the first “two deficits” approach is predicated on not upsetting the bond markets while the administration tries to get to full employment, because upsetting the bond market could put us right back at square one. If confidence drops while increasing aggregate demand the stimulative effort will be compromised.  We need to keep confidence in check.

This new idea is that making the bond market happy in-and-of-itself will produce prosperity and full employment through increasing confidence. The major drag on the economy isn’t low aggregate demand but confidence. Now the assumption isn’t that we have to keep the bond markets as happy as they were but instead make them much happier, which will then increase investments and spending through this increase in confidence.  Hence long-term spending cuts, lots of gimmies to incumbents in supply-side investments and other things powerful interests love but don’t necessarily make demand-based economic sense.

I simply don’t see any evidence of why, or even how, this would work. What are the arguments that confidence is the major check on the economy?  I understood the “two deficit” argument (though I disagreed with it), but this new approach is just substituting in the interests of bondholders for the entire economy.  If a very-polite version of expansion austerity is guiding the administration’s thought then this is even more of a disaster than these stories convey.

And this is where the administration’s “keep the financial markets going and confident at all costs” approach to the financial crisis, ranging from PPIP to not investigating mortgage-servicing fraud, takes over for general economic policy.  And that original approach was pioneered by Geithner, who is now apparently running the economic show.