Bryan Caplan  

Jones on CNN Money

Heavyweight Endorsements for C... The Remote Control Puzzle...
My wise colleague Garett Jones has the office next to mine, so I can question him just by shouting.  (We've got thin walls in Carow Hall).  But now that Garett's writing for CNN Money, it's getting much easier for people other than me to find out what he's thinking.  Here's Garett on debt-for-equity swaps:

The advantage to this approach, said Garett Jones, an economics professor at George Mason University in Fairfax, Va., is that it would help to spread the losses in the financial system to shareholders and bank creditors, instead of leaving the whole tab with taxpayers.

He said the government should force debt-for-equity swaps at institutions needing assistance. Existing shareholders would be wiped out and current creditors would give up some of their debt claims in exchange for ownership of the restructured firm.

In addition to being fairer, Jones said, swapping debt for equity would reduce the amount of debt weighing on the economy. That's a crucial concern at a time when the amount of domestic nonfinancial debt outstanding more than doubles gross domestic product, according to Ned Davis Research data - a ratio that's well above its long-run average.

"Why should taxpayers be bailing out firms when debtholders have plenty of skin in the game?" Jones said. "In the current bailout, what you're really doing is converting the debt of these problem banks to government debt -- and that's not what you need to do."
Garett also answers the public's questions (# 3, 4, 6, 7, 10 specifically) on CNN Money Summit.  Sample:
Question: "The popular response to splitting the bailout money amongst taxpayers instead of the banks is that the recipients will save it, not spend it. Would a government-backed 'debit card' or 'gift card' be an alternative? I feel that it would because it would *have* to be spent and couldn't be saved, as cash could be." - Will Durnan, Scottsdale, Ariz.


Answer: ...If the goal is to raise demand for consumer goods today, then yes, it would help a little.

But in this recession as in most, the biggest fall in spending isn't caused by consumers cutting back: It's caused by businesses cutting back. The big puzzle of recessions is why business spending collapses. Handing debit cards to consumers probably won't do much to get businesses buying more machines, more software and more buildings.

In this recession, as in most, it's the collapse in investment that needs the most fixing. So in order to get economists on board with debit cards, you'd have to show that all this extra consumer spending would somehow cure the collapse in business spending. And there isn't much evidence for that idea. 
Garett is one of the few macroeconomists from whom I still learn new things.  Hopefully that won't prevent him from becoming a media star!

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COMMENTS (11 to date)
mjohns2 writes:

I fail to see how giving out a debit card or gift card is any different than giving out cash in the first place. If the consumer is set on saving that money then they will spend the gift card on something they otherwise would have bought with cash (gas and groceries come to mind), thus saving that amount of money.

Brad Hutchings writes:

Pretty much what Arnold has been saying about profits lately. And the interesting implication here is that if you just give stimulus checks to consumers, and they indeed spend, businesses likely won't spend any more than the incremental cost of sales. Instead, they'll take profits. Business spending problem not solved. And business isn't overinvested in permanent capacity that only needed to be temporary.

MattYoung writes:

Be fair, let the existing shareholders keep 20%.

Bill Woolsey writes:

Great on the debt to equity swaps. Failed to explain that FDIC can inject funds in such a swap just like they usually do with a purchase and assumption. But I guess he thinks that is a bad idea.

I don't agree with his view of investment and consumption. If firms don't want to use funds (and resources) for investment, then the funds should be used for consumption and the resources used to produce consumer goods.

While lower interest rates or increasing real balances could result in increased investment, if they don't they result in increased consumption.

A decrease in investment demand should result in an increase in consumption. The notion that investment demand should must never decrease seems absurd to me.

Matthew C. writes:

This bank bailout is infuriating. Private profits when times are good followed by socialized losses when investment decisions don't work out.

There is NO REASON for taxpayers to be on the hook for these bank losses until common shareholders, preferred shareholders, and then bondholders are each zeroed out in turn. Anything else is completely unacceptable. The fact that this is not happening simply means that the bankers are getting their politician cronies to steal from the taxpayer.

Ivan writes:

Jones said

"The big puzzle of recessions is why business spending collapses. Handing debit cards to consumers probably won't do much to get businesses buying more machines, more software and more buildings.

In this recession, as in most, it's the collapse in investment that needs the most fixing."

This is "puzzle" only for someone who never read Prices and Production. Business spending collapses because of inter-temporal misallocation of resources spurred by central banks expansive monetary policy. Too roundabout projects started with artificially low interest rates must be liquidated, and such a process has its costs. It takes a time to set up new sustainable structure of production through recession.

Bill Woolsey writes:

The claim that inflation has led to an unsustainable capital structure includes the claim that there is a demand for consumer goods now that cannot be met. There should be shortages of consumer goods. Some capital goods will be abandoned because necessary resources are being pulled away form them to produce consumer goods. Focusing on consumer goods, there should be inflation.

The falling demand for consumer goods, the immediate drop of productiong of conumer goods, and the falling prices of consumer goods are inconsistent with story.

More concretely, there should be reduced production of houses and falling housing prices. (Fits current conditions.) There should be an expansion in the production of consumer good or other capital goods that had been starved for resources as housing was overbuilt. The rising demand for these other goods would raise their prices in the short run much more than output. That is because many of the capital goods devoted to building houses (sawmills, for example) cannot be switched very well to other products.

Real incomes fall (or rise less, anyway) and unemployment shinks in housing and expands only gradually in other areas of the economy as labor and other resources can be absorbed.

That the demand for all other investment and consumption is falling, is inconsistent with the story.

I think most of those who appeal to Hayek or Mises half undersand the theory, and use it as a partial rationaliztion for a "liquidationist" theory that is inconsistent with fundamental econmy concepts like scarcity and opportunity cost.

Garett Jones writes:

@ Ivan:

"Puzzle" is just a shorthand. The MSM don't want a lot of details. If I had more time I'd say that every serious business cycle theory wrestles with investment volatility, but there's no consensus yet on which current theory (if any) explains more than, say, 80% of actual investment volatility.

So it's a puzzle from the profession's point of view.

Some examples:

RBCers have an explanation (e.g., Crusoe-style rational responses to bad weather); Keynesians have an explanation (e.g., animal spirits/herding); New Keynesians have an explanation (e.g., money and velocity shocks + sticky inflation); Austrians have an explanation (e.g., adaptive-expectations model of long-term real interest rates + costly sectoral shifts).

Perhaps someday, in the eschatalogical future, we'll know which combination of these (or something else) is the right explanation. But I don't think we're there just yet.

Lord writes:

There is a great fall in investment because those investments were bad, housing number one among them. There is also a great fall in investments that while seemingly good in themselves were predicated on spending from the false profits generated by this and from the bad debt being created, cars and most consumer goods being among these. There was too much investment in these for the false market and now these must be written off. There is no lack of goods that more investment would solve but rather a surplus that cannot be afforded. Now there is some investment that can make sense, but this investment is innovative and risky. It is small and scattered. It takes time to develop and grow, and it is not in a position to help us much now. So now we have a long tough slog to write off bad inventory, bad debt, and bad investment. The best way to ease and hurry the process and reduce the overhang is more inflation to combat deflation. Debit cards are interchangeable with cash so that doesn't get you anywhere but more cash, a lot more cash, say $8000 per citizen, in people's hands is just what is needed.

MattYoung writes:

"The big puzzle of recessions is why business spending collapses."

Try oil at $150, it is not a puzzle. Oil went from zero inventory to capacity restraint on inventory and under utilization of pipeline. From $150 to $40 in the span of a few months.

This might be a clue.

Ivan writes:

"The falling demand for consumer goods, the immediate drop of productiong of conumer goods, and the falling prices of consumer goods are inconsistent with story."

Not in the slightest. Investment shrank much more than consumption and that is the only prediction Austrian theory makes. Fall in the investment spending usually is accompanied with credit crunch that leads to overall fall in prices of both production and consumption goods. It is not necessary for consumption goods to rise in prices but only to fall less than production goods (what is clearly the case now). Thesis that Austrian theory must predict rising consumption goods prices in recession is very common fallacy propagated by Krugman, Cowen and other Keynsians, but without any basis in the theory itself.

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