16 Ideas for the Next Stimulus Package

Regular (and voracious) reader Ennyman tipped me to Incentives Matter, an economics blog by the lyrically-named economist Pedro Albuquerque (see Ennyman's interview with Albuquerque). As if on cue, yesterday saw the posting of Albuquerque's 16 directives for the U.S. government should follow to restore the economy with a minimum of long-term negative impact. It's a bit late for this go-round, but since Stimulus II is already being discussed, these ideas will probably come up.

In posting them, I will comment on a few that I think might spark some debate, and perhaps some expansion on his thoughts by Albuquerque himself.

No government action will lack transparency or imply privileges of any kind.

The government will maintain its role as an impartial referee, enforcing the rules of the game and never participating as one of the players.

No shareholder or CEO will be bailed out. Recapitalization of firms will only happen if strictly necessary to avoid systemic failure, and only after all original equity has been wiped out, according to bankruptcy principles.

4. The government will partially or totally recover the cost of recapitalization by auctioning equity of recapitalized firms. No equity of recapitalized firms will remain on the hands of the government.

5. The government will not be allowed to have executive powers in recapitalized firms.

6. The government will facilitate the administrative handling of bankruptcy proceedings if necessary, respecting however preexisting contracts

7. The Fed will maintain the goal of keeping inflation low, however with more emphasis on financial stability, even if it comes at the cost of some short-term economic growth or interest rate stability.

8. The Fed will formally commit itself to avoid deflation at all costs.

9. No new government program will be funded. Current government programs that are at risk and are considered essential will be funded if necessary at the cost of increased budget deficits. Their funding will nonetheless obey to standard budgetary priorities and procedures.

10. Fiscal stimulus will operate mostly through permanent or temporary tax cuts that promote consumption and investment.

11. The government will not create obstacles to firms and households that wish to reduce their levels of indebtedness and will not suggest that they should do otherwise.

12. Reduction of indebtedness will not be done through contractual breaches and rewrites or through excessive inflation.

13. Negative income tax benefits or lump-sum transfers will be used as the primary tools to help the poor and unemployed. Terms and benefits of unemployment insurance will not be extended or improved to avoid long-term negative consequences to employment.

14. No government action will empower worker or industry unions of any kind.

15. No government action will serve as obstacle to free trade.

16. No government officer will suggest that the world will end and the mountains will crumble to the sea, no matter how tempting it may be to do it.

Albuquerque concludes by arguing that

If judged by the sixteen directives above, government actions until now have left much to be desired. In reality, most of what the government has been doing is in direct conflict with these directives.

UPDATE: Pedro has posted a gracious and thorough response on his blog. Or, go to the next page to see the full post.

Michael Fitzgerald on BNET makes valid points and asks interesting questions regarding my previous post on the sixteen directives for economic recovery policy design. I'll try to address them in this post.

I'd like to start by explaining why I used the word "directives" instead of "suggestions" or "proposals." It was intended to be a tongue-in-cheek commentary on the tendency of governments to present principles of action as orders. The irony behind these "directives" is that they regulate government more than anything else -- just as our Constitution does.

Why is it important to have these "directives"? To avoid the unintended consequences and abuses of government power that tend to creep up during periods of crisis. It also avoids the use of the crisis as an excuse to promote special interests. Naturally, this is all easier said than done.

Now, let me address Michael's comments. Regarding directive 4, "the government will partially or totally recover the cost of recapitalization by auctioning equity of recapitalized firms. No equity of recapitalized firms will remain on the hands of the government." Michael asks:

This one would seem to have the benefit of setting a clear value for bank stocks and other failing firms, toxic assets and all. On the downside, there will not be the chance for taxpayers to earn big profits on the stock if the firms recover.

1. Markets are supposed to price the firms correctly once they've been recapitalized. Besides, stock prices may end up not increasing by any significant amount after auctioning, or may even fall, so why wait? Is the government supposed to know how to price them better than markets? Is the government able to predict the future? I don't think so. As a principle, governments must never hold equities anyway (the referee cannot be one of the players).
2. I don't like the idea of letting the government second-guess the right moment to sell equities. Dangerous stuff (did I mention yet that the referee cannot be one of the players?).
3. The cost of cleaning up assets will have to be borne by society one way or another. Policy cannot change this, but it can alter economic incentives (leading to more efficient outcomes) and the distribution of costs, benefits and risks (who bears what). Cheap prices during auctioning of recapitalized firms for example would create incentives for investors to bet on the economic recovery, despite elevated risks reflected in cheap prices. Would this be a bad thing? Probably not. On the other hand, if the government doesn't auction cheap stocks and holds equity, the government will be the one taking the risks implicit in the low prices. Should taxpayers carry the risk burden through government ownership of equity? Clearly not.
4. Will there be distributional effects in case of economic recovery? Sure there will be. However, the redistribution in this case will at least be aligned with correct incentives and will be based on merit (although judgments of merit are subjective, and therefore open to discussion).

It seems straightforward on the surface. But does it actually suggest that the government should not be able to regulate even firms it has saved? Should the government not have a car czar for Detroit? What about Freddie Mac and Fannie Mae? And how should we represent taxpayers' interests for firms that have been deemed worthy of saving, such as AIG?

In practice, apply to recapitalized firms the same administrative framework that's usually adopted during bankruptcy procedures until equity is auctioned out. Government has no business in managing firms.

Regarding directives 10, "fiscal stimulus will operate mostly through permanent or temporary tax cuts that promote consumption and investment," and 11, "the government will not create obstacles to firms and households that wish to reduce their levels of indebtedness and will not suggest that they should do otherwise," Michael asks:

Numbers 10 and 11 seem contradictory. If the government is not to suggest we increase our debt levels, why should it also promote consumption? Not that we have to buy things on credit, but that does seem to be the pattern here. Also, as much as I feel overburdened by taxes, cutting them seems likely to create more debt for my kids' generation.

Regarding directive 12, "reduction of indebtedness will not be done through contractual breaches and rewrites or through excessive inflation," Michael asks:

How about a Jubilee year?

Regarding directive 13, "negative income tax benefits or lump-sum transfers will be used as the primary tools to help the poor and unemployed. Terms and benefits of unemployment insurance will not be extended or improved to avoid long-term negative consequences to employment," Michael asks:

The first part of 13 makes good sense. But the idea of constraints on unemployment insurance don't seem to mesh with recent work by Ivan Werning and Robert Shimer (see, for instance, Liquidity and Insurance for the Unemployed).

Regarding directive 14, "no government action will empower worker or industry unions of any kind," Michael asks:

I'm not sure where he's going with this. Does he want to ban unions? Is he bashing unions for trying to create better lives for their members, especially in the wake of the 1930s? Is he reacting to contracts that now make management look spineless, and blaming the unions for these?

Regarding directive 16, "no government officer will suggest that the world will end and the mountains will crumble to the sea, no matter how tempting it may be to do it," Michael asks:

Hear, hear. (But what if it's true?)

Anyway, I want to thank Michael for the comments.