Friday, July 30, 2010
TV Fiscal Stimulus Debate Reveals Some Agreement
PBS Newshour hosted a live TV debate between Mark Zandi and me yesterday on the question of whether government interventions helped or hurt the economy. The show highlighted a paper by Alan Blinder and Zandi about which I posted comments on this blog yesterday. Several people who watched the show commented on how Zandi agreed with me on two important issues: (1) that the on-again off-again bailout policies in 2008 helped bring about the panic that year and (2) that holding off on any tax rate increases next year would be a stimulus to economic growth. Of course we disagreed about other things.
Thursday, July 29, 2010
More on the Blinder-Zandi Working Paper on the Crisis
Yesterday the New York Times published an article about simulations of the effects of fiscal stimulus packages and financial interventions using an old Keynesian model. The simulations were reported in an unpublished working paper by Alan Blinder and Mark Zandi. I offered a short quote for the article saying simply that the reported results were completely different from my own empirical work on the policy responses to the crisis.
I have now had a chance to read the paper and have more to say. First, I do not think the paper tells us anything about the impact of these policies. It simply runs the policies through a model (Zandi’s model) and reports what the model says would happen. It does not look at what actually happened, and it does not look at other models, only Zandi’s own model. I have explained the defects with this type of exercise many times, most recently in testimony at a July 1, 2010 House Budget Committee hearing where Zandi also appeared. I showed that the results are entirely dependent on the model: old Keynesian models (such as Zandi’s model) show large effects and new Keynesian models show small effects. So there is nothing new in the fiscal stimulus part of this paper.
Second, I looked at how they assessed the impact of the financial market interventions. Again they do not directly assess the interventions. They just simulate the model with and without the interventions. They say that they have equations in the model which include the financial interventions as variables, but they do not report the size or significance of the coefficients or how they obtained them.
Third, the working paper makes no mention of previously published papers in the literature which get different results. It is rather standard in research to provide a literature review and to explain why the results are different from previous published papers. For the record there are different results in papers by John Cogan, Volcker Wieland, Tobias Cwik and me in the Journal of Economic Dynamics and Control, by John Williams and me in the American Economic Journal; Macroeconomics, or by me published by the Bank of Canada or the St. Louis Fed
Finally, when I read the paper I discovered in an appendix that Blinder and Zandi find that policy was not as good as the model shows and was in fact quite poor when one does a more comprehensive evaluation. They say in Appendix A that “Poor policymaking prior to TARP helped turn a serious but seemingly controllable financial crisis into an out-of-control panic. Policymakers’ uneven treatment of troubled institutions (e.g., saving Bear Stearns but letting Lehman fail) created confusion about the rules of the game and uncertainty among shareholders, who dumped their stock, and creditors, who demanded more collateral to provide liquidity to financial institutions.” I completely agree with this statement, but how can one then argue that policy intervnetions worked, when, in fact, viewed in their entirety they caused the problem?
I have now had a chance to read the paper and have more to say. First, I do not think the paper tells us anything about the impact of these policies. It simply runs the policies through a model (Zandi’s model) and reports what the model says would happen. It does not look at what actually happened, and it does not look at other models, only Zandi’s own model. I have explained the defects with this type of exercise many times, most recently in testimony at a July 1, 2010 House Budget Committee hearing where Zandi also appeared. I showed that the results are entirely dependent on the model: old Keynesian models (such as Zandi’s model) show large effects and new Keynesian models show small effects. So there is nothing new in the fiscal stimulus part of this paper.
Second, I looked at how they assessed the impact of the financial market interventions. Again they do not directly assess the interventions. They just simulate the model with and without the interventions. They say that they have equations in the model which include the financial interventions as variables, but they do not report the size or significance of the coefficients or how they obtained them.
Third, the working paper makes no mention of previously published papers in the literature which get different results. It is rather standard in research to provide a literature review and to explain why the results are different from previous published papers. For the record there are different results in papers by John Cogan, Volcker Wieland, Tobias Cwik and me in the Journal of Economic Dynamics and Control, by John Williams and me in the American Economic Journal; Macroeconomics, or by me published by the Bank of Canada or the St. Louis Fed
Finally, when I read the paper I discovered in an appendix that Blinder and Zandi find that policy was not as good as the model shows and was in fact quite poor when one does a more comprehensive evaluation. They say in Appendix A that “Poor policymaking prior to TARP helped turn a serious but seemingly controllable financial crisis into an out-of-control panic. Policymakers’ uneven treatment of troubled institutions (e.g., saving Bear Stearns but letting Lehman fail) created confusion about the rules of the game and uncertainty among shareholders, who dumped their stock, and creditors, who demanded more collateral to provide liquidity to financial institutions.” I completely agree with this statement, but how can one then argue that policy intervnetions worked, when, in fact, viewed in their entirety they caused the problem?
Wednesday, July 21, 2010
More Economists Voice Concerns about Deficit-Spending Proposals
The number of economists arguing forcefully against efforts to use more deficit spending to stimulate the economy is increasing. Their arguments differ in important respects, ranging from empirical evidence that the stimulus programs thus far have done little to help the economy to the recognition that the growing debt is a serious threat to long term growth and economic stability. Already this week we have
Niall Ferguson's Today's Keynesians Have Learned Nothing,
Ken Rogoff's No Need for A Panicked Fiscal Surge,
Vernon Smith's Please, No More Government Spending ,
and my Cutting National Debt = Stimulus.
The bottom line is that we can help the economy more by laying out a credible plan to end the debt explosion.
Niall Ferguson's Today's Keynesians Have Learned Nothing,
Ken Rogoff's No Need for A Panicked Fiscal Surge,
Vernon Smith's Please, No More Government Spending ,
and my Cutting National Debt = Stimulus.
The bottom line is that we can help the economy more by laying out a credible plan to end the debt explosion.
Monday, July 19, 2010
Government Policy and the Slowdown
Is the economy slowing down and what has been the role of government? Recently EconTalk host Russ Roberts and I discussed these questions and our conversation was made available today as a podcast at the Library of Economics and Liberty.
Like many economists, I am concerned about the slowdown in the economy which prolongs the high unemployment rate. I think uncertainty about the growing federal debt and the increased government interventions—from health care to financial markets—is the cause of the slowdown. In my view the best stimulus right now would be a clear and credible plan to reduce the deficit and bring down the growing debt.
Like many economists, I am concerned about the slowdown in the economy which prolongs the high unemployment rate. I think uncertainty about the growing federal debt and the increased government interventions—from health care to financial markets—is the cause of the slowdown. In my view the best stimulus right now would be a clear and credible plan to reduce the deficit and bring down the growing debt.
Sunday, July 18, 2010
New Data Show the Debt Problem Is Spending (not Taxes) and Obamacare Worsens the Problem
Everyone now seems to agree that the exploding federal debt is a serious problem that must be addressed. But how? The following two charts provide some data to help answer that question. I put the charts together using budget data from CBO’s new Long Term Budget Outlook released on June 30. They take account of the budget effect of latest legislation—including the Obamacare bill.
The first chart presents the outlook for spending (red line) and revenue (blue line) as a share of GDP using CBO’s “alternative scenario,” which assumes that President Obama’s tax increase proposal is passed, including increasing the two top income tax rates. The deficit is the difference between the red and blue lines. Thus the chart clearly demonstrates that the deficit is exploding because government spending is exploding.
The chart also shows (green line) what would happen to tax revenue if tax rates stay at their current level and are not increased as President Obama has proposed. Taxes would average about 18.5 percent of GDP compared with 19.3 percent for CBO’s estimate under the Obama tax rate increase. According to the chart the Obama tax increase would not have a material effect on the very large deficit (the chart even overstates the effect because it assumes static budget scoring). Again the problem is spending growth, not taxes. To me this chart implies that it is far better to leave tax rates where they are and focus on a plan to end the explosive spending growth, especially in a weak economic environment where higher marginal tax rates can severely reduce economic growth and employment.
The second chart looks at the reasons for the explosive spending. It divides non-interest spending into three parts: (1) social security, (2) health care (Medicaid, Medicare, and Obamacare) and (3) everything else. Item 2—spending on health care—is clearly the most important source of the spending explosion. Remember that these data came out after Obamacare was passed. Thus, Obamacare does not address the explosive health care spending problem, which will come as no surprise to its critics, but is clearly contrary to the claims of those who supported it. Moreover, to the extent that Obamacare slowed growth in Medicare it more than offset this with new entitlements, making controlling health care spending even more difficult now. The data are clear: In order to control government spending, you have to start over on health care reform. Whether you call that “repeal and replace” or “repeal and reduce (the deficit)” the message is the same.
In sum, these new budget data show three things: First, the deficit is exploding because government spending is exploding. Second, the tax increase proposed by President Obama would not have a material effect on the exploding deficit. Third, we need a new approach to health care reform if we are to control government spending and wind down the deficit.
The first chart presents the outlook for spending (red line) and revenue (blue line) as a share of GDP using CBO’s “alternative scenario,” which assumes that President Obama’s tax increase proposal is passed, including increasing the two top income tax rates. The deficit is the difference between the red and blue lines. Thus the chart clearly demonstrates that the deficit is exploding because government spending is exploding.
The chart also shows (green line) what would happen to tax revenue if tax rates stay at their current level and are not increased as President Obama has proposed. Taxes would average about 18.5 percent of GDP compared with 19.3 percent for CBO’s estimate under the Obama tax rate increase. According to the chart the Obama tax increase would not have a material effect on the very large deficit (the chart even overstates the effect because it assumes static budget scoring). Again the problem is spending growth, not taxes. To me this chart implies that it is far better to leave tax rates where they are and focus on a plan to end the explosive spending growth, especially in a weak economic environment where higher marginal tax rates can severely reduce economic growth and employment.
The second chart looks at the reasons for the explosive spending. It divides non-interest spending into three parts: (1) social security, (2) health care (Medicaid, Medicare, and Obamacare) and (3) everything else. Item 2—spending on health care—is clearly the most important source of the spending explosion. Remember that these data came out after Obamacare was passed. Thus, Obamacare does not address the explosive health care spending problem, which will come as no surprise to its critics, but is clearly contrary to the claims of those who supported it. Moreover, to the extent that Obamacare slowed growth in Medicare it more than offset this with new entitlements, making controlling health care spending even more difficult now. The data are clear: In order to control government spending, you have to start over on health care reform. Whether you call that “repeal and replace” or “repeal and reduce (the deficit)” the message is the same.
In sum, these new budget data show three things: First, the deficit is exploding because government spending is exploding. Second, the tax increase proposed by President Obama would not have a material effect on the exploding deficit. Third, we need a new approach to health care reform if we are to control government spending and wind down the deficit.
Sunday, July 4, 2010
A Chart for the Fourth of July
Just before Americans started celebrating the July 4th weekend, the Congressional Budget Office (CBO) released its annual Long Term Budget Outlook. The chart shows the CBO projection of the federal debt (as a percent of GDP) assuming that current law or policies do not change as defined in the CBO alternative fiscal scenario (CBO Outlook in 2010). The chart also shows the CBO’s long term projection at the same time last year (CBO Outlook in 2009). And for comparison the chart also shows the history of the debt going back to the time of the founding of the country. 
Like the fireworks tonight, you can see one explosion after another, and one higher than the one before. But unlike the fireworks tonight, these are not the kind of explosions you want to see.
We can hope that Washington gets its act together in time for next year’s July 4th celebration so that CBO can make a non-exploding debt projection, like the one at the lower right of the chart. In this lower projection the debt is equal to the 67 percent of GDP currently forecast for 2011, but it then declines in an orderly manner until it reaches 40 percent of GDP, rather than the 947 percent of GDP now projected for 2084. As I testified at the House Budget Committee last Thursday, I think such a plan—if it is clear and credible—would be a much better stimulus to growth and job creation than another “stimulus package” of the kind we saw in recent years.
For more information about the CBO projection, you can examine their spreadsheet by clicking on “additional info.”
Like the fireworks tonight, you can see one explosion after another, and one higher than the one before. But unlike the fireworks tonight, these are not the kind of explosions you want to see. We can hope that Washington gets its act together in time for next year’s July 4th celebration so that CBO can make a non-exploding debt projection, like the one at the lower right of the chart. In this lower projection the debt is equal to the 67 percent of GDP currently forecast for 2011, but it then declines in an orderly manner until it reaches 40 percent of GDP, rather than the 947 percent of GDP now projected for 2084. As I testified at the House Budget Committee last Thursday, I think such a plan—if it is clear and credible—would be a much better stimulus to growth and job creation than another “stimulus package” of the kind we saw in recent years.
For more information about the CBO projection, you can examine their spreadsheet by clicking on “additional info.”
Thursday, July 1, 2010
Financial Reform with False Remedies and Errors of Omission
A common criticism of the Dodd-Frank bill keeps coming up as more people wade through the several hundred sections, or at least summaries of them. This common criticism is that the bill contains many false remedies and errors of omission. The criticism comes from both the left and the right. See, for example, these two pieces: "The Failure of Financial Reform, Itemized" by John Talbott in the Huffington Post and "Phony Financial Reform" by Thomas Donlan in Barron's. While political factors—special interest lobbying, social activist pressures, covering up past mistakes—were probably behind much of the bill, economic analysis shows that the problem is that it is based on a misdiagnosis of the financial crisis, as I wrote in this op-ed which appeared in the July 1 Wall Street Journal.
The bill will be taken up by the Senate later in the month, but is it too much to ask that they wait until the Financial Crisis Inquiry Commission finishes its diagnosis in December? If you want to find out more about the bill, you can download all 2300+ pages, but beware that it is 74 megabytes.
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