Here’s why giving every American $1,200 is a really bad idea

By Steven Pearlstein. He is a Washington Post economics columnist and the Robinson professor of public affairs at George Mason University, is the author of “Can American Capitalism Survive?”

"It is yet another sign of our political dysfunction that a government that dithered for weeks before getting serious about fighting a global pandemic now can’t take a few days for thoughtful debate about how to spend a trillion dollars to deal with the economic fallout.

Make no mistake: The Senate Republican plan to send every household $1,200 for each adult and $500 for every child is a really dumb idea. It is not just an inefficient and ineffective way to stabilize the economy — it’s also a cynical ploy by President Trump and the Republican leaders in Congress to buy the next election. Even more surprising is that it seems to have won the reflexive support of liberal Democrats who have become so fixated on economic inequality, so addicted to fiscal stimulus and so desperate to win back the white working class that their instinct isn’t to oppose it, but to demand the checks be even larger.

Let’s just do a little simple arithmetic.

There are about 330 million people living in the United States. About 75 million of those are children under the age of 18. There are about 10 million students who spend most of their time studying at colleges and universities. And there are 65 million Americans who live primarily off pensions and monthly checks from the Social Security Administration. Few of those 150 million children, students and seniors will lose much income as a result of layoffs and business closures caused by the pandemic.

In addition, there are, by my count, roughly 100 million workers who are likely to continue to receive most of their normal wage and salary income either because they will continue to show up for work, or work from home, or be paid even though they are not working.

This 100 million includes about 33 million government workers and public school teachers who will continue to be paid. It includes 3 million farmers who will continue to produce our food, 1 million people involved in processing and distributing that food and 3 million workers at grocery and beverage stores who will sell it. And it includes the 3 million people working for information technology, Internet and telecommunications companies that will keep us all wired up and entertained, the 9 million working in finance and the 10 million in law, accounting, consulting and other professional firms, most of whom are already working at home.

Let’s not forget the millions of workers who will be kept on the payrolls in the airline, cruise line, hotel and hospitality industries as a result of a $150 billion federal rescue package and millions more at smaller firms that will continue to meet payroll, thanks to $300 billion in loans from the Small Business Administration.

That leaves about 80 million Americans whose income may be in jeopardy. To be sure, that’s a lot of workers needing help and a big hit to the economy. But those are not challenges best met by sending $1,200 checks to 250 million of their fellow citizens who are still getting paychecks and can’t even spend what they make — they can’t go shopping, or take a vacation or even go out for a nice dinner.

The better strategy is to get money into the hands of cash-strapped businesses that promise to use it to keep workers on their payrolls — or, if that fails, to get it into the hands of laid off workers who will probably spend it on essentials.

As an alternative, if the government were to send those 80 million laid off workers a $500 check (tax free) every week for eight weeks, that would be $4,000 apiece — enough to keep their collective spending somewhere close to where it is now. And at $320 billion, that would be significantly less than the White House and Republican Senate leaders propose to spend.

The only reason this foolish proposal is under serious consideration is that it was cooked up in secret over the weekend by politicians spooked by the rout on the stock market, worried about losing the next election and desperate to show they are doing something “big” other than bailing out private industries. There was no serious analysis done by professionals at the White House, Treasury or the Congressional Budget Office, no input from congressional committees, no consultation with Democrats and certainly no public debate.

Now we are told by some who ought to know better that if Congress fails to throw a trillion dollars at the problem in the next few days, tens of millions of sales clerks and restaurant waiters and Uber drivers will go hungry, get thrown out of their homes and lose their Internet access, and economic Armageddon will be upon us.

“Give Every American $2,000, Immediately,” demanded the very serious people at the New York Times in Thursday’s lead editorial, a mishmash of economic nonsense, liberal grievances and Democratic talking points.

We need to stop for a moment and take a deep breath. This is a scary time. A lot has happened in the past three weeks. People are dying. Panic has overtaken financial markets. Countries are locking down their citizens and closing their borders. The global economy is tumbling into recession. Governments need to pull people together, act boldly and lend and spend freely.

Freely, but not stupidly. The right antidote for not doing any of the right things for too long is not to do too much of the wrong thing too fast. Sending money to millions of voters who don’t need it and can’t spend it may be good politics, but its lousy economics."

Yellen Says She’s ‘Not a Fan of MMT’ as List of Detractors Grows

By Enda Curran of Bloomberg.


"Former Federal Reserve chief Janet Yellen said she’s not a fan of modern monetary theory, saying its proponents are “confused” about what can fuel inflation in the economy.

Yellen took issue with those promoting MMT who suggest “you don’t have to worry about interest-rate payments because the central bank can buy the debt,” she said at an Asian investors’ conference hosted by Credit Suisse in Hong Kong. “That’s a very wrong-minded theory because that’s how you get hyper-inflation.”


The former Fed chair said she was “not a fan” when asked about the decades-old theory, which has gained recent traction in the U.S. particularly amid a run-up in government debt. Yellen joins a list of well-known names such as billionaire investor Warren Buffett and former U.S. Treasury Secretary Larry Summers who have said they’re opposed to the theory."

The 2008 Financial Crisis

By Arnold Kling. Excerpts:

"From roughly 1990 to the middle of 2006, the housing market was characterized by the following:

• an environment of low interest rates, both in nominal and real (inflation-adjusted) terms. Low nominal rates create low monthly payments for borrowers. Low real rates raise the value of all durable assets, including housing.
• prices for houses rising as fast as or faster than the overall price level
• an increase in the share of households owning rather than renting
• loosening of mortgage underwriting standards, allowing households with weaker credit histories to qualify for mortgages.
• lower minimum requirements for down payments. A standard requirement of at least ten percent was reduced to three percent and, in some cases, zero. This resulted in a large increase in the share of home purchases made with down payments of five percent or less.
• an increase in the use of new types of mortgages with “negative amortization,” meaning that the outstanding principal balance rises over time.
• an increase in consumers’ borrowing against their houses to finance spending, using home equity loans, second mortgages, and refinancing of existing mortgages with new loans for larger amounts.
• an increase in the proportion of mortgages going to people who were not planning to live in the homes that they purchased. Instead, they were buying them to speculate. 3

These phenomena produced an increase in mortgage debt that far outpaced the rise in income over the same period. The trends accelerated in the three years just prior to the downturn in the second half of 2006."

"Policy failure played a big role in the housing sector. All of the trends listed above were supported by public policy. Because they wanted to see increased home ownership, politicians urged lenders to loosen credit standards. With the Community Reinvestment Act for banks and Affordable Housing Goals for Freddie Mac and Fannie Mae, they spurred traditional mortgage lenders to increase their lending to minority and low-income borrowers. When the crisis hit, politicians blamed lenders for borrowers’ inability to repay, and political pressure exacerbated the credit tightening that subsequently took place"

"There was policy failure in that abuses in the sub-prime mortgage sector were allowed to continue. Ironically, while the safety and soundness of Freddie Mac and Fannie Mae were regulated under the Department of Housing and Urban Development, which had an institutional mission to expand home ownership, consumer protection with regard to mortgages was regulated by the Federal Reserve Board, whose primary institutional missions were monetary policy and bank safety. Though mortgage lenders were setting up borrowers to fail, the Federal Reserve made little or no effort to intervene. Even those policy makers who were concerned about practices in the sub-prime sector believed that, on balance, sub-prime mortgage lending was helping a previously under-served set of households to attain home ownership."

"There was policy failure on the part of bank regulators. Their previous adverse experience was with the Savings and Loan Crisis, in which firms that originated and retained mortgages went bankrupt in large numbers. This caused bank regulators to believe that mortgage securitization, which took risk off the books of depository institutions, would be safer for the financial system. For the purpose of assessing capital requirements for banks, regulators assigned a weight of 100 percent to mortgages originated and held by the bank, but assigned a weight of only 20 percent to the bank’s holdings of mortgage securities issued by Freddie Mac, Fannie Mae, or Ginnie Mae. This meant that banks needed to hold much more capital to hold mortgages than to hold mortgage-related securities; that naturally steered them toward the latter.

In 2001, regulators broadened the low-risk umbrella to include AAA-rated and AA-rated tranches of private-label CDOs. This ruling helped to generate a flood of PLMS, many of them backed by sub-prime mortgage loans.7

By using bond ratings as a key determinant of capital requirements, the regulators effectively put the bond rating agencies at the center of the process of creating private-label CDOs. The rating agencies immediately became subject to both moral hazard and cognitive failure. The moral hazard came from the fact that the rating agencies were paid by the issuers of securities, who wanted the most generous ratings possible, rather than being paid by the regulators, who needed more rigorous ratings. The cognitive failure came from the fact that that models that the rating agencies used gave too little weight to potential scenarios of broad-based declines in house prices. Moreover, the banks that bought the securities were happy to see them rated AAA because the high ratings made the securities eligible for lower capital requirements on the part of the banks. Both sides, therefore, buyers and sellers, had bad incentives.

There was policy failure on the part of Congress. Officials in both the Clinton and Bush Administrations were unhappy with the risk that Freddie Mac and Fannie Mae represented to taxpayers. But Congress balked at any attempt to tighten regulation of the safety and soundness of those firms"

"There was policy failure when Congress passed the Commodity Futures Modernization Act. This legislation specified that derivatives would not be regulated by either of the agencies with the staff most qualified to understand them. Rather than require oversight by the Securities and Exchange Commission or the Commodity Futures Trading Commission (which regulated market-traded derivatives), Congress decreed that the regulator responsible for overseeing each firm would evaluate its derivative position. The logic was that a bank that was using derivatives to hedge other transactions should have its derivative position evaluated in a larger context. But, as it happened, the insurance and bank regulators who ended up with this responsibility were not equipped to see the dangers at firms such as AIG.

There was also policy failure in that officials approved of securitization that transferred risk out of the regulated banking sector. While Federal Reserve Officials were praising the risk management of commercial banks,11risk was accumulating in the shadow banking sector (non-bank institutions in the financial system), including AIG insurance, money market funds, Wall Street firms such as Bear Stearns and Lehman Brothers, and major foreign banks. When problems in the shadow banking sector contributed to the freeze in inter-bank lending and in the market for asset-backed commercial paper, policy makers felt compelled to extend bailouts to satisfy the needs of these non-bank institutions for liquid assets."

OECD Economic Research Finds That Government Spending Harms Growth

By Daniel J. Mitchell of Cato. Excerpts:

"A new working paper by two economists at the OECD contains some remarkable findings about the negative impact of government spending on economic performance. If you’re pressed for time, here’s the key takeaway from their research:

Governments in the OECD spend on average about 40% of GDP on the provision of public goods, services and transfers. The sheer size of the public sector has prompted a large amount of research on the link between the size of government and economic growth. …This paper investigates empirically the effect of the size and the composition of public spending on long-term growth… The main findings that emerge from the analysis are… Larger governments are associated with lower long-term growth. Larger governments also slowdown the catch-up to the productivity frontier.

For those who want more information, the working paper is filled with useful information and analysis.

Here’s one of the charts from the study, showing how government spending is allocated in OECD nations.

The report also acknowledges that there’s a lot of preexisting research showing that government spending hinders economic growth.

There is a vast empirical literature investigating the relationship between the size of the government and economic growth (see Slemrod, 1995; Myles 2009; Bergh and Henrekson, 2011 for overviews). A review by Bergh and Henrekson (2011), based on papers published in peer reviewed journals after 2000, suggested a negative relationship in OECD countries. Likewise, a recent OECD study confirmed a negative relationship between the size of government and GDP growth (Fall and Fournier, 2015). …the link between the size of government and growth may vary with the income level and could be hump-shaped (Armey, 1995). A few studies have found support for the existence of a non-linear relationship between the size of government and growth (e.g. Vedder and Gallaway, 1998; Pevcin, 2004; Chen and Lee, 2005).

By the way, the reference to “hump-shaped” means that the OECD is even aware of the Rahn Curve.
The methodology in the paper is not ideal from my perspective. For all intents and purposes, the economists compare economic performance of the OECD’s big-government nations with the growth numbers from the OECD’s not-quite-as-big-government nations. But even with that limitation, the study generates some powerful results.

…the simulation assumes that in countries where the size of government is above the average level of countries in the bottom half of the sample, the government size will gradually converge to this level (36% of GDP). Similar to the spending mix reforms, this reform is phased in over 10 years. Such a reduction in the size of the government could increase long-term GDP by about 10%, with much larger effects in some countries with currently large or ineffective governments. …a reduction of the size of government has a positive, but moderate, effect on the income of the poor. The average disposable income also rises. However, the rich gain relatively more. Finally, in countries where the government is less effective (such as Italy) the growth effect dominates and a moderate reduction of the size of government would have a large growth effect, so that it would lift all boats.

And here’s a chart showing how much more growth would be possible if the countries with really-big government downsized their public sectors to the somewhat-big level.

Even with the methodology limitations I described, these results are astounding. Potential GDP gains of more than 30 percent for Greece and Italy. Gains of more than 20 percent for Slovenia, France, and Hungary. And more than 10 percent for Belgium, Czech Republic, Portugal, and Poland.

The working paper also looks at the composition of government spending. In other words, just as not all taxes are equally damaging, the same is true for spending programs.

The results from the estimation of the size of the government and the public spending mix illustrate that public spending matters for long-term growth…pension and subsidy spending [are] the two items with a significantly negative effect on growth. As each regression includes the size of government and one spending share, the estimates provide the effect of increasing this type of spending while decreasing spending on other items to keep the spending to GDP ratio unchanged… larger governments are in several specifications significantly and negatively associated with long-term growth. This is consistent with the literature… Larger governments can impede convergence (Table 8, columns 1 and 3), because they are associated with higher taxation that can discourage business investment including foreign investment and households to supply labour.

Pensions and subsidies seem to cause the most economic harm.

Reducing the share of pension spending in primary spending yields sizeable growth gains with no significant adverse effect on disposable income inequality. This reduction could be achieved by an increase in the effective retirement age or by cutting the replacement rate. …Cutting public subsidies boosts growth, as public subsidies…can distort the allocation of resources and undermine competition. …Education outcomes depend not only on education spending but also on the effectiveness of education policies, and the literature suggest the latter can be more important. Since the seminal work of Coleman (1966), a broad literature suggests that there is no clear link between education spending and education outcomes. …policies aimed at increasing education spending effectiveness can be more appropriate than an across-the-board rise of education spending. …It may be that, beyond a certain point, additional spending on investment has adverse effects, if poorly managed.

For those of you with statistical/econometric knowledge, here’s some relevant data from the study.

 

And you can match the numbers in Table 6 with these excerpts.

…pension spending reduces growth (Table 6, columns 2, 5, 7 and 10). Increasing the share of pension spending in primary spending by one percentage point (offset by a reduction in other spending) would decrease potential GDP by about 2%. …Public spending on subsidies also reduces growth (Table 6, columns 3, 5, 8 and 10).

…increasing the share of public subsidies in primary spending by one percentage point would decrease potential GDP by about 7%.

If you’re not a stats wonk, these two charts may be more helpful and easy to understand.


What jumped out at me is how the normally sensible nation of Switzerland is very bad about subsidies. That’s a policy they obviously need to fix (along with the fact that they also have a wealth tax, which is very uncharacteristic for that country).
But I’m digressing.

Let’s return to the study. One of the interesting things about the working paper is that it notes that bad fiscal policy can be somewhat mitigated by having market-oriented policies in other areas, which is a point I always make when writing about Scandinavian nations.

…countries with a high level of public spending may also be characterised by features that partly offset the adverse growth effect of government size. …in Sweden the mix of growth-friendly structural policies…may have offset the adverse growth effect of a large government sector.

In other words, the moral of the story is that smaller government is good and free markets are good. Mix the two together and you have best of all worlds.

P.S. Even if the OECD published dozens of quality studies like this one, I would still argue that American taxpayers should no longer be forced to subsidize the Paris-based bureaucracy. And even if the OECD’s political types stopped pushing statist policies, I would still have the same view about ending handouts from American taxpayers. This has nothing to do with the fact that the bureaucrats once threatened to have me arrested and thrown in a Mexican jail. I simply don’t think taxpayers should fund international bureaucracies.

P.P.S. Other international bureaucracies, including the World Bank and European Central Bank, also have published good research about the negative effect of excessive government spending."

In defense of rational expectations models

By Scott Sumner.

"David Glasner has a post criticizing the rational expectations modeling assumption in economics:

What this means is that expectations can be rational only when everyone has identical expectations. If people have divergent expectations, then the expectations of at least some people will necessarily be disappointed -- the expectations of both people with differing expectations cannot be simultaneously realized -- and those individuals whose expectations have been disappointed will have to revise their plans. But that means that the expectations of those people who were correct were also not rational, because the prices that they expected were not equilibrium prices. So unless all agents have the same expectations about the future, the expectations of no one are rational. Rational expectations are a fixed point, and that fixed point cannot be attained unless everyone shares those expectations. Beyond that little problem, Mason raises the further problem that, in a rational-expectations equilibrium, it makes no sense to speak of a shock, because the only possible meaning of "shock" in the context of a full intertemporal (aka rational-expectations) equilibrium is a failure of expectations to be realized. But if expectations are not realized, expectations were not rational.

I see two mistakes here. Not everyone must have identical expectations in a world of rational expectations. Now it's true that there are ratex models where people are simply assumed to have identical expectations, such as representative agent models, but that modeling assumption has nothing to do with rational expectations, per se.

In fact, the rational expectations hypothesis suggests that people form optimal forecasts based on all publicly available information. One of the most famous rational expectations models was Robert Lucas's model of monetary misperceptions, where people observed local conditions before national data was available. In that model, each agent sees different local prices, and thus forms different expectations about aggregate demand at the national level.
It's also wrong to say:

But if expectations are not realized, expectations were not rational.

Suppose I am watching the game of roulette. I form the expectation that the ball will not land on one of the two green squares. Now suppose it does. Was my expectation rational? I'd say yes---there was only a 2/38 chance of the ball landing on a green square. It's true that I lacked perfect foresight, but my expectation was rational, given what I knew at the time.

In 2006, it might have been rational to forecast that housing prices would not crash. If you lived in many countries, your forecast would have been correct. If you happened to live in Ireland or the US, your forecast would have been incorrect. But it might well have been a rational forecast in all countries."

The crisis did not reveal that the previous consensus framework for monetary policy should be fundamentally reconsidered

See Should the Previous Framework for Monetary Policy Be Fundamentally Reconsidered? by John Taylor. Excerpt:

"Over time more complex empirical models with rational expectations and sticky prices (new Keynesian) provided better underpinnings for this monetary policy framework. Many of the new models were international with highly integrated capital markets and no-arbitrage conditions on the term-structure. Soon the new Keynesian FRB/US, FRB/Global and SIGMA models replaced the MPS and MCM models at the Fed. The objective was to find monetary policy rules which improved macroeconomic performance.  The Taylor Rule is an example, but, more generally, the monetary policy framework found that rules-based monetary policy led to better economic performance in the national economy as well as in the global economy where an international Nash equilibrium in “rule space” was early optimal.

This was the monetary policy framework that was in place at the time of the financial crisis.  Many of the models that underpinned this framework can be found in the invaluable archives of the Macro Model Data Base (MMB) of Volker Wieland where there are many models dated 2008 and earlier including the models of Smets and Wouters, of Christiano, Eichenbaum, and Evans, of De Graeve, and of Taylor. Many models included financial sectors with a variety of interest rates; the De Graeve model included a financial accelerator.  The impact of monetary shocks was quite similar in the different models, as shown here and summarized in the following chart of four models, and simple policy rules were robust to different models.

Perhaps most important, the framework worked in practice. There is overwhelming evidence that when central banks moved toward more transparent rules-based policies in the 1980s and 1990s, including through a focus on price stability, there was a dramatic improvement compared with the 1970s when policy was less rule-like and more unpredictable.  Moreover, there is considerable evidence that monetary policy deviated from the framework in recent years by moving away from rule-like policies, especially during the “too low for too long” period of 2003-2005 leading up to the financial crisis, and that this deviation has continued. In other words, deviating from the framework has not worked.

Have the economic relationships and therefore the framework fundamentally changed since the crisis?  Of course, as Tom Sargent puts it in his editorial  review of the forthcoming  Handbook of Macroeconomics by Harald Uhlig and me, “both before and after that crisis, working macroeconomists had rolled up their sleeves to study how financial frictions, incentive problems, incomplete markets, interactions among monetary, fiscal, regulatory, and bailout policies, and a host of other issues affect prices and quantities and good economic policies.”  But, taking account of this research, the overall basic macro framework has shown a great degree of constancy as suggested by studies in the new Handbook of Macroeconomics. For example, Jesper Linde, Frank Smets, and Raf Wouters examine some of the major changes—such as the financial accelerator or a better modeling of the zero lower bound. They find that these changes do not alter the behavior of the models during the financial crisis by much.  They also note that there is little change in the framework—despite efforts to do so—to incorporate the impact of unconventional policy instruments such as quantitative easing and negative interest rates.  In another paper in the new Handbook, Volker Wieland, Elena Afanasyeva, Meguy Kuete, and Jinhyuk Yoo examine how new models of financial frictions or credit constraints affect policy rules. They find only small changes, including a benefit from including credit growth in the rules.

All this suggests that the crisis did not reveal that the previous consensus framework for monetary policy should be fundamentally reconsidered, or even that it has fundamentally changed. This previous framework was working.  The mistake was deviating from it.  Of course, macroeconomists should keep working and reconsidering, but it’s the deviation from the framework—not the framework itself—that needs to be fundamentally reconsidered at this time. I have argued that there is a need to return to the policy recommendations of such a framework domestically and internationally.

We are not there yet, of course, but it is a good sign that central bankers have inflation goals and are discussing policy rules. Janet Yellen’s policy framework for the future, put forth at Jackson Hole in August, centers around a Taylor rule.  Many are reaching the conclusion that unconventional monetary policy may not be very effective. Paul Volcker and Raghu Rajan are making the case for a rules-based international system, and Mario Draghi argued at Sintra in June that “we would all clearly benefit from enhanced understanding among central banks on the relative paths of monetary policy. That comes down, above all, to improving communication over our reaction functions and policy frameworks.”"

The U.S. Postwar Miracle

By David Henderson of EconLog.

"Co-blogger Scott Sumner posted yesterday some interesting facts and figures about the post World War II economic boom in the United States that came after the U.S. government cut government spending massively.

I wrote a study on this for Mercatus in 2010 and highlighted some of the findings in this post in November 2010.

Two things I want to highlight.

First, as I wrote then, "federal government spending on goods and services fell, in a period of two to three years, by over one third of GDP." That puts in perspective Gary Johnson's proposal to cut government spending by 20 percent. A 20 percent cut in federal government spending, when government spending is about 20 percent of GDP, is a 4-percentage-point cut in government spending as a percent of GDP. In other words, Johnson proposes to cut government spending as a percent of GDP by about one eighth of the percent by which Truman and Congress cut it in 2 to 3 years.
Second, I want to answer the question raised by one of the commenters who said:

Real GDP declined an unprecedented 12.7% from 1944 to 1946. Hardly "fine".

I answered this point at length in my Mercatus study. Here's an excerpt from my answer:

According to official government data, the U.S. economy suffered its worst one-year recession in history in 1946. The official data show a 12-percent decline in real GNP after the war. A 12-percent decline in one year would fit anyone's idea of not just a recession, but an outright depression. So, is the story about a postwar boom pure myth? If you ask most people who were young adults in those years (a steadily diminishing number of people, so talk to them soon) about economic conditions after the war, they will talk about "the postwar boom." They saw it as a time of prosperity.

The same commenter, Ben, wrote:

Sure, unemployment didn't increase substantially at all which was likely due to a high demand for workers as women returned home and left the workforce again.

I answered this in some detail in my Mercatus study also. I called this the "Rosie the Riveter Goes Home" explanation. It turns out that half of the additional women who entered the work force during WWII did not go home.

Here's what I wrote in the study:

"There was no surge in unemployment," goes the first explanation, "because women left the defense plants and went back to being housewives and raising families." This explanation is half true and totally misleading. First, approximately half of the women who entered the labor force in the early 1940s stayed. The number of women in the labor force rose from 14.5 million in 1941 to a peak of 19.4 million in 1944, declining to 16.9 million in 1947. In other words, of the 4.9 million women who entered the labor force between 1941 and 1944, 2.4 million stayed in the labor force. Thus, there was still a need for millions of jobs to open up for newly demobilized male soldiers. The fact that the unemployment rate stayed in the low single digits is an outstanding success story.
Second, what defense plants? Almost all of them shut down or reconverted to peacetime uses after the war. Women who wanted to stay employed had to find other private work. As [Robert] Higgs points out, "[T]he real miracle was to reallocate a third of the total labor force to serving private consumers and investors in just two years.""

The Clinton Plan’s Growth Deficit

Hillary’s agenda is long on economic platitudes. How is more money for roads—$50 billion a year—going to kick-start growth?

By John H. Cochrane in the WSJ.

"Larry Summers, Democratic economic adviser extraordinaire, wrote recently in the Washington Post that growth is “the single most important determinant of almost every aspect of economic performance,” and that trying to boost it “has been discredited in the minds of too many progressives.”"

"Her central pro-growth proposal is “infrastructure” spending, $275 billion over five years, financed in part by some sharply higher taxes."

"Nobody thinks that stagnant growth is centrally the fault of bad roads and bridges."

"Spend taxed or borrowed money on anything, and the “multiplier” will increase “demand.”"

"We’ve been at this since 2008. But the caution that stimulus should be “timely, targeted, and temporary” has now been forgotten. Japan’s massive “infrastructure” spending and weak growth to show for it are forgotten. And if U.S. growth hasn’t been kick-started by the trillions of stimulus so far—the government has accumulated $8 trillion of debt since the recession began—how will another $50 billion a year help?

Further, why are roads and bridges still a problem? President Obama has been after “infrastructure” stimulus since 2009. If you ask that question, and listen to answers, they are pretty clear. It’s nearly impossible to build infrastructure these days. Endless regulatory reviews and legal challenges bog down builders."

"If the Sierra Club sues to block her worthy commitment to “upgrade our dams and levees,” will she really short-circuit the legal process, and how?

The rest of Mrs. Clinton’s economic agenda is a thousand-course smorgasbord of government expansions, with the same deficiencies. A random sample: Higher taxes on capital gains and corporations. New taxes on financial transactions. A corporate exit tax. Paid leave. Free college. A higher minimum wage. More federal training programs."

"The “plan” offers neither a strategy for enactment, nor thought about why these are problems in the first place. Yes, it’s hard to find quality affordable childcare. Why? Could licensing, zoning, teachers unions, minimum wages, ObamaCare mandates, employee time rules, taxes, immigration restrictions and the like have something to do with it?"

Government Spending Might Not Create Jobs Even during Recessions

By Bill Dupor & Rodrigo Guerrero, writing for the St. Louis Fed. Excerpts:

"The effectiveness of fiscal policy is often questioned because its positive impact on employment and output may be dampened by secondary effects that "crowd out" economic activity in the private sector. For instance, if the expenditure is financed by borrowing, then this borrowing might exert upward pressure on interest rates, which, in turn, would cause a reduction in private investment. Similarly, a surge in fiscal spending may bid up wages, thereby reducing the demand for labor in the private sector.

Times of high unemployment usually see an uptick in calls for increased government spending from politicians, pundits and economists. These observers appeal to a logic for government intervention that might not be valid during normal economic times; they argue that the detrimental secondary effects of fiscal spending are not as prominent when the economy is slack.

The simple thinking is that because the government's demand for goods and services can be met with otherwise idle workers, additional public spending need not bid up wages significantly or crowd out private demand.

whether government spending is particularly effective at increasing economic activity during times of high unemployment is an empirical question. A large amount of research has been conducted on the effects of government purchases on output (or gross domestic product) during recessions; relatively less research has focused on these purchases' employment effects. Understanding the employment effects of government intervention during recessions is crucial—much of the brunt from downturns, such as the 2007-2009 recession, is likely felt by people losing their jobs.

Public Spending and Employment

A researcher ideally would like to see macroeconomic experiments with government spending changing over time for reasons unrelated to business cycle fluctuations and also to have these experiments occur during both high- and low-unemployment times. These exogenous changes would generate natural experiments akin to the controlled experiments used to test, for example, the efficacy of new drugs.

Although truly exogenous large changes in government spending do not exist in the U.S. (or probably anywhere else), we in the U.S. have something close in the form of defense spending. Defense spending can be used because changes in it are mostly determined by international geopolitical factors rather than macroeconomic conditions. In our new research, we employed a recently created data set containing more than 120 years' worth of data on government purchases; the data set was introduced in a series of papers by economists Michael Owyang, Valerie Ramey and Sarah Zubairy.1 These data appear in the upper panel of the figure. They include episodes of large variation in government spending during both low-unemployment times, such as World War I and the Korean War, and high-unemployment times, such as World War II.

The spending data also include a time series of "defense news shocks." Using historical documents, such as Business Week magazine, Ramey constructed a time series of changes in the values of future military spending. These data appear in the lower panel of the figure. Note, for example, the large upward spikes near the start of World War II and the downward spikes as that war neared its end. Since this series is based on military purchases that were not motivated by business cycle conditions, the data help to identify the exogenous component of the government spending shocks. Moreover, it is important to use news about military spending to tease out exogenous changes rather than military spending itself because households and businesses may change their behavior in response to new information even if the actual defense spending is months to years away. For instance, a military contractor might react to news about future government purchases by increasing its workforce in anticipation of higher demand.

The upper panel of the figure plots real (inflation-adjusted) per capita government spending between 1890 and 2010. The shaded bars indicate years when, according to our measure, the labor market was slack, i.e., the unemployment rate was greater than 6.5 percent. In addition to a general upward trend, there are spikes in government spending. The most notable ones result from World War I and World War II. The lower panel of the figure plots the military news variable. At each quarter, it gives the change in the present value of expected future defense spending as a fraction of gross domestic product (GDP). For many periods, its values are zero, which indicate periods where beliefs about future defense spending are unchanged. Not surprisingly, there are major positive spikes around the times of World War I and World War II.

Specifically, our research aims to answer the following two questions: (1) By how much does national civilian employment change when government spending increases? (2) Is this estimate dependent on the unemployment level at the time in which the spending occurs?2 We used the news about military spending to infer the quantitative response of employment to exogenous changes in government spending.

Small Employment Effects

We found that, in the short and intermediate run, there are only small employment effects of government spending in both high- and low-unemployment times. We quantified the effects of government spending over a four-year horizon following exogenous news about future U.S. defense spending.

Following a policy change that begins when the unemployment rate is high, if government spending increases by 1 percent of GDP, then total employment increases by between 0 percent and 0.15 percent. Following a policy change that begins when the unemployment rate is low, the same government spending increase causes total employment to change by –0.4 percent and 0 percent.3 Although the effect is larger during times of high unemployment, even then, the employment effect of government spending is low.

In the longer run (e.g., seven or eight years), we also found almost no effect on employment from government spending. The estimated effects are not statistically different from zero. The main difference is that in the long run we cannot reject the possibility that the effect of public spending on employment is the same during times of high and low unemployment. This is due to the fact that we lose precision in the estimation at longer horizons.

Conclusion

The question of the efficacy of countercyclical fiscal policy during downturns is far from settled. It is important that macroeconomists continue to study the issue. As horse racing fans say, there is a lot of money riding on it. For example, the total budget impact of the most recent U.S. stimulus ($840 billion for the American Recovery and Reinvestment Act of 2009) was larger than U.S. defense spending in Iraq since 9/11.4, 5

Endnotes

1. Our paper largely follows the approach of a 2013 study by Michael Owyang, Valerie Ramey and Sarah Zubairy. [back to text]
2. In answering these questions, we used two econometric adjustment procedures. First, we estimated the dynamic effects using the local projections method to allow the effect of spending to vary depending upon whether the unemployment rate is high or low. Second, we used instrumental variables with defense news shocks to correct for the possibility that government spending is endogenous to local business-cycle conditions. [back to text]
3. These ranges are based on 90 percent confidence intervals. [back to text]
4. According to a 2014 study by Amy Belasco, between the 9/11 attacks and the end of 2014, congressional appropriations for military operations in Iraq totaled $815 billion. [back to text]
5. Our findings suggest that the drop in unemployment since 2009 was probably not a result of the Recovery Act's spending component. Understanding the reasons for the decline in unemployment is a topic that warrants further exploration. [back to text]

References

Belasco, Amy. "The Cost of Iraq, Afghanistan, and Other Global War on Terror Operations since 9/11." Congressional Research Service, Dec. 8, 2014.
Dupor, William; and Guerrero, Rodrigo. "Robust Inference about Fiscal Multipliers." Unfinished manuscript.
Fox, Justin. "The Comeback Keynes." Time, Vol. 172, No. 18, Nov. 3, 2008, p. 60.
Owyang, Michael; Ramey, Valerie; and Zubairy, Sarah. "Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data." American Economic Review, Vol. 103, No. 3, 2013, pp. 129-34.
Ramey, Valerie. "Identifying Government Spending Shocks: It's All in the Timing." Quarterly Journal of Economics, Vol. 126, No. 1, 2011, pp. 1-50."

The Austrian theory of the business cycle continues its comebacka

From Tyler Cowen at Marginal Revolution.

"Except no one seems interested in calling it by that name.  Here is the new NBER working paper by David López-Salido, Jeremy C. Stein, and Egon Zakrajšek, “Credit-Market Sentiment and the Business Cycle”:

Using U.S. data from 1929 to 2013, we show that elevated credit-market sentiment in year t – 2 is associated with a decline in economic activity in years t and t + 1. Underlying this result is the existence of predictable mean reversion in credit-market conditions. That is, when our sentiment proxies indicate that credit risk is aggressively priced, this tends to be followed by a subsequent widening of credit spreads, and the timing of this widening is, in turn, closely tied to the onset of a contraction in economic activity. Exploring the mechanism, we find that buoyant credit-market sentiment in year t – 2 also forecasts a change in the composition of external finance: net debt issuance falls in year t, while net equity issuance increases, patterns consistent with the reversal in credit-market conditions leading to an inward shift in credit supply. Unlike much of the current literature on the role of financial frictions in macroeconomics, this paper suggests that time-variation in expected returns to credit market investors can be an important driver of economic fluctuations."

Did the Euro cause malinvestment?

See Further results in Austro-Italian business cycle theory at Marginal Revolution.

"You may think this is from the Journal of Masonomics, but no it is an NBER Working paper:

Following the introduction of the euro in 1999, countries in the South experienced large capital inflows and low productivity. We use data for manufacturing firms in Spain to document a significant increase in the dispersion of the return to capital across firms, a stable dispersion of the return to labor across firms, and a significant increase in productivity losses from misallocation over time. We develop a model of heterogeneous firms facing financial frictions and investment adjustment costs. The model generates cross-sectional and time-series patterns in size, productivity, capital returns, investment, and debt consistent with those observed in production and balance sheet data. We illustrate how the decline in the real interest rate, often attributed to the euro convergence process, leads to a decline in sectoral total factor productivity as capital inflows are misallocated toward firms that have higher net worth but are not necessarily more productive. We conclude by showing that similar trends in dispersion and productivity losses are observed in Italy and Portugal but not in Germany, France, and Norway.

The authors are Gita Gopinath, Sebnem Kalemli-Ozcan, Loukas Karabarbounis, and Carolina Villegas-Sanchez.  You don’t have to be a hard-core Austrian to think that malinvestment is the most under-used word in contemporary macroeconomics."