Yes, I know that it’s only Thursday afternoon. But I’m off to dinner with friends now, and I have a nightmare travel day tomorrow — three different flight segments, almost 12 hours from first takeoff to final landing. So it’s now or never.

It took me a while to get into THATH; for some reason, some of their most viewed videos aren’t the best performances. But they have an amazing, distinctive sound built around three lead vocalists singing close harmony. And given what I said about tomorrow’s plan, this performance — on what was obviously a brutally hot day — seems appropriate:

Sorry about the failure to post anything earlier. It was a combination of family responsibilities and, to be frank, sheer weariness over the folly of our public life. And I really don’t feel up to any extended discussion even now. Instead, just a few short takes on things that caught my eye:

Chaos Theory: Politico reports that Democrats are planning to run against Congressional Republicans by portraying them as incapable of acting responsibly, of creating “chaos”.

This line of attack has the virtue of being true; the 112th Congress was the Worst Congress Ever, and it wasn’t because of the Democrats. But it will be an uphill struggle, essentially because the news media still, after all these years, can’t bring themselves to abandon “balanced” reporting in which every GOP sin must be matched with an equal Democratic sin, even if the latter has to be invented out of thin air. Can the message break through that fog of confusion?

The decline of Pimco macro, continued:A while back I noted that macroeconomic analysis at the bond giant Pimco seemed to have gone downhill after Paul McCulley left; a firm that had shown a keen appreciation of the special problems of a deleveraging economy started making really bad analyses based on the notion that the Fed’s quantitative easing was driving everything — and lost a lot of money as a result.

I guess I shouldn’t be surprised to see Bill Gross doubling down on his mistakes. Still, it’s sad.

Geithner going: Bloomberg reports that Tim Geithner will leave before the debt ceiling crisis hits. I hate to say this, but I find this reassuring. While I have no insider information here, I’ve had the sense that Geithner has consistently been a voice urging the president to cave in for fear of upsetting the markets, with no real concern for the dangers of giving in to blackmail. His departure makes it at least somewhat more likely that Obama will stand his ground.

That’s all my substantive stuff for today. Off to the economics meetings in San Diego!

I’ve had communications from a number of people asking an interesting question relating to the debt ceiling and other issues: why does the Federal government have to borrow at all? Why can’t it just print money to pay its bills? After all, haven’t people like me been saying that this isn’t actually inflationary?

Now, it turns out that there really is a problem, or actually two problems — but they’re a bit subtle.

First, as a legal matter the Federal government can’t just print money to pay its bills, with one peculiar exception. Instead, money has to be created by the Federal Reserve, which then puts it into circulation by buying Federal debt. You may say that this is an artificial distinction, because the Fed is effectively part of the government; but legally, the distinction matters, and the debt bought by the Fed counts against the debt ceiling.

The peculiar exception is that clause allowing the Treasury to mint platinum coins in any denomination it chooses. Of course this was intended as a way to issue commemorative coins and stuff, not as a fiscal measure; but at least as I understand it, the letter of the law would allow Treasury to stamp out a platinum coin, say it’s worth a trillion dollars, and deposit it at the Fed — thereby avoiding the need to issue debt.

In reality, to pursue the thought further, the coin really would be as much a Federal debt as the T-bills the Fed owns, since eventually Treasury would want to buy it back. So this is all a gimmick — but since the debt ceiling itself is crazy, allowing Congress to tell the president to spend money then tell him that he can’t raise the money he’s supposed to spend, there’s a pretty good case for using whatever gimmicks come to hand.

But leaving the debt ceiling on one side, isn’t it true that since spending can currently be financed by Fed money printing, we shouldn’t care at all about the notional debt owed to the Fed? Alas, no.

It’s true that printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public.

We are living in weird economic times, where many of the usual rules don’t apply and there are big free lunches to be had. But not everything is a free lunch, even now. Sorry.

So, the Times has a story about Latvia. If you read it carefully, it’s not a puff piece; it says that things have improved from their worst, but are still very tough despite the eagerness of some to proclaim it a wonderful success story.

And that’s exactly right. Here’s employment over time*:

So we’re looking at a Depression-level slump, and 5 years later only a partial bounceback; unemployment is down but still very high, and the decline has a lot to do with emigration. It’s not what you’d call a triumphant success story, any more than the partial US recovery from 1933 to 1936 — which was actually considerably more impressive — represented a huge victory over the Depression.

And it’s in no sense a refutation of Keynesianism, either. Even in Keynesian models, a small open economy can, in the long run, restore full employment through deflation and internal devaluation; the point, however, is that it involves many years of suffering — in the long run we are all dead.

So the adulation over Latvia really tells us more about what the European policy elite wants to believe than it does either about the realities of Latvian experience or the fundamentals of macroeconomics.

*Data from Eurostat. Serious eurowonks will notice that there is a break in the series at the beginning of 2012, as they adjusted the population controls (because so many people have emigrated!). I dealt with this by using the Eurostat rate-of-growth numbers (pdf) to estimate employment in 2012.

More thoughts about the fiscal deal:

One good thing is that the deficit scolds are furious: they had their hearts set on exploiting this crisis to push through benefit cuts, and it didn’t happen — part of the larger good news that Obama didn’t gut Social Security or Medicare this time around.

And as I pointed out yesterday, the numbers are disappointing, but the disappointment isn’t that big a deal. Let me offer more detail on that.

Before the deal, it was widely expected that Obama could get $800 billion in revenue. You may wonder how this reconciles with the much bigger numbers in his original proposal; the answer is that part of this came from the estate tax, on which he couldn’t count on backing from Senate Dems, but most of it came from going beyond just getting rid of the Bush tax cuts — he was proposing that itemized deductions be turned into tax credits at a maximum of 28 percent, which would have collected a lot of additional revenue from people in the 39.6 bracket. And that wasn’t something he could get just by going over the cliff.

So the disappointment, to simplify, is that he got $600 billion instead of $800 billion. Now, you want to scale that by the size of the fiscal problem.

The deficit is no problem now, but eventually we will emerge from the liquidity trap, and at that point you do want to start stabilizing debt. How big a deal is that? If you look at the CBO numbers, under their “alternative fiscal scenario” (Bush tax cuts extended and realistic spending), in 2022 the deficit would be 5.5 percent of GDP, about 2 percentage points higher than would be required to stabilize debt at 90 percent of GDP.

So what we eventually need is something like 2 or more points — probably more, because aging and the rise in health care costs won’t stop in 2022. Now, that’s nothing like the catastrophic sense about the budget you get from the usual suspects, but it is big compared with anything we’ve seen so far.

As I pointed out in the last post, nominal GDP over the next decade should be around $200 trillion. An $800 billion revenue take would be 0.4 percent of GDP; the $600 billion Obama got is 0.3 percent. Not big stuff, and either way the big fight over taxes versus benefit cuts is still to come.

So, why am I feeling so despondent, and why do so many other progressives, like Noam Scheiber, feel the same? Because of the way Obama negotiated. He gave every indication of being more or less desperate to cut a deal before the year ended — even though going over the fiscal cliff was not at all a drop-dead moment, since we could have gone weeks or months without much real economic damage.

Now, given his evident antsiness to cut a deal in this case, how credible is his promise to hang tough over the debt ceiling, which is a much brighter red line? He may say that he absolutely, positively won’t negotiate over the ceiling — but nothing in his past behavior makes that believable.

Maybe this time will be different. Maybe the Treasury is secretly preparing to invoke the 14th amendment, or issue a trillion-dollar platinum coin, or direct that the whole budget gap be taken out of spending dear to Republicans. But I have to say that I now expect Obama to cave on the ceiling; and so, of course, do the Republicans, which means that the crisis is going to happen.

The only thing that might save this situation is the fact that Obama has to be aware just how much is now riding on his willingness to finally stand up for his side; if he doesn’t, nobody will ever trust him again, and he will go down in history as the wimp who threw it all away.

But even that may not be enough. I guess we’ll see.

To make sense of what just happened, we need to ask what is really at stake, and how much difference the budget deal makes in the larger picture.

So, what are the two sides really fighting about? Surely the answer is, the future of the welfare state. Progressives want to maintain the achievements of the New Deal and the Great Society, and also implement and improve Obamacare so that we become a normal advanced country that guarantees essential health care to all its citizens. The right wants to roll the clock back to 1930, if not to the 19th century.

There are two ways progressives can lose this fight. One is direct defeat on the question of social insurance, with Congress actually voting to privatize and eventually phase out key programs — or with Democratic politicians themselves giving away their political birthright in the name of a mess of pottage Grand Bargain. The other is for conservatives to successfully starve the beast — to drive revenue so low through tax cuts that the social insurance programs can’t be sustained.

The good news for progressives is that danger #1 has been averted, at least so far — and not without a lot of anxiety first. Romney lost, so nothing like the Ryan plan is on the table until President Santorum takes office, or something. Meanwhile, in 2011 Obama was willing to raise the Medicare age, in 2012 to cut Social Security benefits; but luckily the extremists of the right scuttled both deals. There are no cuts in benefits in this deal.

The bad news is that the deal falls short on making up for the revenue lost due to the Bush tax cuts. Here, though, it’s important to put the numbers in perspective. Obama wasn’t going to let all the Bush tax cuts go away in any case; only the high-end cuts were on the table. Getting all of those ended would have yielded something like $800 billion; he actually got around $600 billion. How big a difference does that make?

Well, the CBO estimates cumulative potential GDP over the next decade at $208 trillion.So the difference between what Obama got and what he arguably should have gotten is around 0.1 percent of potential GDP. That’s not crucial, to say the least.

And on the principle of the thing, you could say that Democrats held their ground on the essentials — no cuts in benefits — while Republicans have just voted for a tax increase for the first time in decades.

So why the bad taste in progressives’ mouths? It has less to do with where Obama ended up than with how he got there. He kept drawing lines in the sand, then erasing them and retreating to a new position. And his evident desire to have a deal before hitting the essentially innocuous fiscal cliff bodes very badly for the confrontation looming in a few weeks over the debt ceiling.

If Obama stands his ground in that confrontation, this deal won’t look bad in retrospect. If he doesn’t, yesterday will be seen as the day he began throwing away his presidency and the hopes of everyone who supported him.

OK, I’ve had my own sorta-kinda briefing on the apparent fiscal cliff deal, and I’m pretty much with Noam Scheiber. Viewed on its own, it’s a bad and upsetting deal but not as terrible as initial rumors had it. But the strategic consequences are likely to be very bad indeed, and in very short order too.

As background, it’s important to understand what Obama clearly could have gotten just by going over the cliff. Basically, he could have gotten the whole of the Bush high-end tax cuts reversed, which would mean close to $800 billion in revenue over the next decade. What he couldn’t get, or at least couldn’t count on getting, were various spending items. This included the extension of unemployment benefits and various “refundables” on things like the Earned Income Tax Credit, that is, pieces of tax legislation that end up having the government cut checks to families instead of the other way around.

So what Obama appears to have done is trade away part of the revenue from high-income taxpayers in return for some of the spending items he wanted. Extended unemployment benefits for a year, and the refundables either extended in perpetuity or for 5 years.

The revenue loss seems to be on the order of $150 billion, or maybe a bit less. The reasons it isn’t bigger is that while the threshold for the top marginal rate is moving up to 450K, the thresholds for other things — phaseout of deductions, higher taxes on dividends and capital gains — aren’t going up, they’re staying at 250K.

And at least one positive thing can be said: no giveaway on Social Security, Medicare, or Medicaid. Basically, no spending cuts at all.

If you want think about the longer-term implications here, they’re ambiguous. The deficit is no problem right now, but there will eventually be a collision between the rising costs of social insurance programs and the inadequacy of the revenue base. Something will have to give.

There were two big risks, from a progressive point of view, in Obama’s eagerness to get a Grand Bargain. One was that he would allow the Bush tax cuts to be locked in, making it very hard to get additional revenue; the other was that he would give in on fundamental benefit cuts. Well, he did #1, partially, but didn’t do #2 at all. This sets up a future confrontation: it will be very hard for progressives to raise taxes, but also very hard for conservatives to cut those social programs.

I suppose the best case you can make here is that raising rates on the top 2 percent was never going to be enough anyway, so Obama getting less from that than he should have isn’t that big a deal. And the nightmare in which he cut Medicare and/or Social Security, only to have Republicans run against those cuts in 2014, seems to have been averted.

OK, now for the really bad news. Anyone looking at these negotiations, especially given Obama’s previous behavior, can’t help but reach one main conclusion: whenever the president says that there’s an issue on which he absolutely, positively won’t give ground, you can count on him, you know, giving way — and soon, too. The idea that you should only make promises and threats you intend to make good on doesn’t seem to be one that this particular president can grasp.

And that means that Republicans will go right from this negotiation into the debt ceiling in the firm belief that Obama can be rolled.

At that point he can redeem himself by holding firm — but because the Republicans don’t think he will, they will play tough, almost surely forcing him to actually hit the ceiling with all the costs that entails. And look, if I were a Republican I would also be betting that he’ll cave.

So Obama has set himself and the nation up for a much uglier confrontation than we would have had if he had set a negotiating position and held to it.

Update: I should mention that on one issue, the estate tax, the problem is apparently with the Senate; there are, unfortunately, some heartland Dem Senators who are extremely solicitous of the handful of super-wealthy families in their states, so that Obama’s people don’t think they can get a majority for higher taxes here. It’s bizarre: states like New Jersey have far more large estates, not just total but per capita, than states like Montana, but it’s the Senators from the latter that are eager to preserve the inherited privileges of the few.

Many reports in the past hour or two suggesting that Obama is about to cave on the fiscal cliff — water down his tax demands in return for some minor Republican concessions — concessions that won’t involve taking the debt ceiling off the table.

Let’s hope this is wrong.

Is it really possible that Obama still doesn’t understand that every time he does this — especially if it comes just a few days after stern statements about how he won’t give it — it just reinforces the Republican belief that he can always be bullied into submission? If he cuts a bad deal on the fiscal cliff today, he more or less guarantees that just a few weeks from now Republicans will go all out on using the debt ceiling to extract more concessions.

So far, these are only reports on background, so maybe the truth isn’t that bad. But suddenly that sinking feeling, the sense that you’ve got a leader you can count on to wimp out when it matters, is back.

Robert Murphy replies to Brad DeLong, and DeLong is not happy — for good reason. But I think there’s also a broader point.

Brad’s ire reflects Murphy’s apparent belief that his failed inflation forecast is OK because we just so happen to have faced a huge deflationary downdraft that offset the inflationary impact of Fed expansion. As Brad says, if that’s right, we should be hailing Ben Bernanke for preventing a catastrophic deflation, not attacking him for doing too much. Indeed, if you believe that there are lots of shocks of this magnitude, you should be a big supporter of activist monetary policy.

My broader point, however, involves Murphy’s main argument, which is “Well, some Keynesians got their unemployment predictions wrong, so there.”

What’s wrong with this line of attack? Two things, actually.

First, it’s really important to distinguish between fundamental predictions of a model and predictions that an economist happens to make that don’t really come from the model. The prediction that huge increases in the monetary base will cause large increases in the price level, and that big government deficits will cause big increases in interest rates, are more or less inescapable if your model of the economy is one in which recessions are supply-side problems, not the result of inadequate demand. Conversely, the prediction that neither of these things will happen if the economy is in a liquidity trap is a fundamental prediction of Keynesian models. On the other hand, the unfortunate Romer-Bernstein prediction of a fairly rapid bounceback from recession reflected judgements about future private spending that had nothing much to do with Keynesian fundamentals, and therefore sheds no light on whether those fundamentals are correct.

In short, some predictions matter more than others.

Beyond that is the question of how you react if your prediction goes badly wrong.

The fact is that while Keynesians predicting a fast recovery weren’t really relying on their models, the failure of that fast recovery has nonetheless prompted quite a lot of soul-searching and rethinking. It is now standard, in a way that it wasn’t before, to argue that recessions that follow financial crises have a very different time path of recovery from other recessions, and that debt overhang, in particular, poses special problems.

So Keynesian thinking has evolved in important ways; we’ve learned from our mistakes (where by “our”, as it happens, I don’t exactly mean “my” — I expected a slow recovery all along; but the actual event has nonetheless led me to substantial rethinking). The fundamental concepts of demand-side slumps and the importance of the zero lower bound remain, but there’s a lot of further refinement that changes the way we think.

Has there been anything comparable on the Austrian/Austerian side? Not that I can see. All I see are excuses — hey, we would have had inflation except for the Europeans, or something. And to return to Brad’s point, there doesn’t even seem to be any consideration of the implications for policy if in fact things like a debt crisis on the other side of the Atlantic can suddenly triple the apparent demand for high-powered money.

Being willing to learn matters. Unfortunately, that willingness seems absent from many people who consider themselves economic experts.

Well, that was quick. For some time it has been obvious to anyone paying attention what the true GOP budget strategy was: demand that Obama make proposals for entitlement cuts, and then

they’ll just pronounce themselves unsatisfied with whatever he comes up with, and are indeed very likely to campaign in 2014 attacking him for whatever cuts take place.

But it turns out that they didn’t even wait for any actual budget deal. Here’s Marco Rubio yesterday (via Ezra Klein):

The first part is, of course, simply a lie: numerous reports tell us that McConnell did in fact make precisely that demand. And let’s remember this when Rubio makes his run for the White House: we already know that he’s an unprincipled liar. But anyway, you see how it will go — and why the whole notion of settling matters fiscal with a Grand Bargain was always crazy. You can’t make big deals with a totally untrustworthy negotiating partner.

Given this blog’s growing readership, I find it necessary every once in a while to remind people of the rules on commenting. In particular, the Grey Lady is very Victorian; comments containing obscenities will not be posted except through oversight. For what it’s worth, by the way, when I do the moderation myself — which is some of the time — the obscene language seems more common in supportive than critical comments. Hey, I often feel like cursing too. No matter, it’s still forbidden

Just for the record, that’s about the only form of censorship practiced here. I’ve banned a couple of known trolls, but haven’t seen them (or him — might be all one person) for a while. Off-topic stuff and non-substantive stuff will be weeded out when caught; this is not the place to talk about how much you hate visiting your aunt.

And please, no whines about why your comment wasn’t posted. Check the times of the comments you see, and almost always the moderator just hasn’t gotten to you yet. The Times has limited resources for moderating here, and while I try to pick up some of the slack, when all is said and done this is an unpaid venture on my part and has to take second place to actual duties, whether they’re academic, journalistic, or familial.

Paul Solman has a post on Greg Mankiw’s attempt at a gotcha over my views circa 2003 on the consequences of deficits. As Solman notes, not only are the situations very different, I’ve also long since acknowledged that I was wrong, and have explained how and why I modified my views as a result. Extra bonus: notice how Mankiw, faced with the failure of his gotcha, immediately tries to claim that he wasn’t actually saying what he was, in fact, saying.

Anyway, as I told Joe Weisenthal, you’re supposed to change your views when events don’t pan out as you expected. The real gotchas should come on people who stick with their ideology no matter how badly it performs in practice.

Brad DeLong vents his spleen on one example, a guy who has been predicting double-digit inflation for years but remains absolutely committed to his framework all the same. Brian Riedl of Heritage, who predicted that the US government would find it especially hard to borrow, and have to pay ever-higher rates, in a global recession, is another.

But we don’t have to go to hard-liners and marginal figures to find people who refuse to learn. Basically the whole austerian movement has been wrong about everything for two and a half years — wrong about interest rates, wrong about the effects of austerity on GDP in Europe. Yet where is the reconsideration?

And utter wrongness seems to be no disqualification for being considered a source of wisdom. It’s hard to top Alan Greenspan’s record these past seven or eight years: he went from denying that there was a housing bubble (or even that such a bubble was possible), to declaring the housing bust over in the fall of 2006, to declaring that US deficits would produce high inflation and interest rates (along with expressing his regret that it hadn’t happened yet). Yet there he was at the founding of Fix the Debt, apparently still considered the Maestro.

So, I’ve learned some things and changed some of my views. Wouldn’t it be nice if other people would do the same, sometimes?

It sure looks as if we’re going over the fiscal cliff, but that may be the least of our problems. The debt ceiling is a much bigger and more dangerous issue, and it looks very much as if Republicans are set to destroy the full faith and credit of the United States if they can’t get their way.

The key thing to remember — and what the GOP hopes you won’t understand — is that raising the debt ceiling only empowers the president to spend money that he’s authorized to spend by Congressional legislation; nothing more. Conversely, a party that refuses to raise the debt limit is saying that it’s prepared to inflict vast damage on America in order to achieve things that it couldn’t achieve through actual legislation — in effect, that it’s prepared to use vandalism to subvert the constitutional process.

Still, that’s where they’re going.

Back in 2003, when I published The Great Unraveling, I got a lot of ridicule from centrists over my claim that modern conservatism, which has taken over the GOP, was a deeply radical movement. (I also got a lot of grief for daring to suggest that Bush led us to war on false pretenses). At this point, does anyone doubt that that’s what we’re seeing?

So what we’re probably looking at over the next few months is an epic confrontation. Maybe Obama wimps out — in which case he’s effectively surrendered the presidency to Grover Norquist; maybe GOP leaders back down, but then face a civil war within their own party; or maybe we’ll have a vast, rolling crisis that won’t truly be resolved until the 2014 elections.

Happy New Year!

Evan Soltas of Wonkblog and Joe Weisenthal of Business Insider both make the same point, in more detail, that I tried to make in my series on ONE TRILLION DOLLARS: the current budget deficit is overwhelmingly the result of the depressed economy, and it’s not clear that we have a structural budget problem at all, let alone the fundamental mismatch between what we want and what we’re willing to pay for that people like to claim exists. Here’s another chart, showing the primary federal balance — that is, not counting interest payments — since 1972 (data from CBO):

It’s hard to look at that chart and not conclude that the slump is the principal cause of the deficit. Soltas suggests, based on a more careful statistical analysis, that the structural budget deficit, including interest, is 2 percent of GDP or less. He also makes an interesting observation: the deficit has become more cyclically sensitive over time thanks to rising inequality. How so? More revenue comes from the wealthy — even though their tax rates have fallen — and their income is more volatile than that of ordinary workers.

So, the whole deficit panic is fundamentally misplaced. And it’s especially galling if you look at what many of the same people now opining about the evils of deficits said back when we had a surplus. Remember, George W. Bush campaigned on the basis that the surplus of the late Clinton years meant that we needed to cut taxes — and Alan Greenspan provided crucial support, telling Congress that the biggest danger we faced was that we might pay off our debt too fast. Now Greenspan is helping groups like Fix the Debt.

And as Duncan Black points out, the Bush experience tells us something important about fiscal policy: namely, that when Democrats get obsessed with deficit reduction, all they do is provide a pot of money that Republicans will squander on more tax breaks for the wealthy as soon as they get a chance. Suppose Romney had won; do you have even a bit of doubt that all the supposed deficit hawks of the GOP would suddenly have discovered that unfunded tax cuts and military spending are perfectly fine?

The point is that the whole focus of budget discussion is based on a combination of bad economics and bad (and fundamentally dishonest) politics. We’re looking not so much at a Grand Bargain as at a Great Scam.

Yes, it’s early, but I’m fiscally exhausted, and am calling it a day. No particular reason to post this performance; it’s just that I happened to stumble across this wonderful live version of “Undiscovered First”, which I especially like because the performers seem tired and out of it until they start playing, and then you watch the power of the song take over:

The backup singers are a group on their own, Mountain Man; you can hear how good they are in this brief performance: