Show Me the Money
A number of economists have been warning about the Federal Reserve’s easy-money policy, but defenders of the central bank often ask, ”if there’s an easy money policy, why isn’t that showing up in the form of higher prices?” Thomas Sowell has an answer to this question, explaining that people and businesses are sitting on cash because anti-business policies have dampened economic activity.
Not only has all the runaway spending and rapid escalation of the deficit to record levels failed to make any real headway in reducing unemployment, all this money pumped into the economy has also failed to produce inflation. The latter is a good thing in itself but its implications are sobering. How can you pour trillions of dollars into the economy and not even see the price level go up significantly? Economists have long known that it is not just the amount of money, but also the speed with which it circulates, that affects the price level. Last year the Wall Street Journal reported that the velocity of circulation of money in the American economy has plummeted to its lowest level in half a century. Money that people don’t spend does not cause inflation. It also does not stimulate the economy. …Banks have cut back on lending, despite all the billions of dollars that were dumped into them in the name of “stimulus.” Consumers have also cut back on spending. For the first time, more gold is being bought as an investment to be held as a hedge against a currently non-existent inflation than is being bought by the makers of jewelry. There may not be any inflation now, but eventually that money is going to start moving, and so will the price level.
I do my best to avoid monetary policy issues and certainly am not an expert on the subject, so I asked a few people for their thoughts and was told that perhaps the strongest evidence for Sowell’s hypothesis comes from the Federal Reserve’s data on “Aggregate Reserves of Depository Institutions” – specifically the figures on excess reserves. This is the money that banks keep at the Federal Reserve voluntarily because they don’t have any better options. As you can see from the chart, excess reserves shot up during the financial crisis. But what’s important is that they did not come back down afterwards. Some people refer to this as “money on the sidelines” and Sowell clearly is worried that it will have an impact on the price level if banks start circulating it. That doesn’t sound like good news. On the other hand, it’s not exactly good news that banks are holding money at the Fed because there are not enough profitable opportunities.
What this really tells us is that the combination of easy money and big government isn’t working any better today than it did in the 1970s.
The Recess Appointment of Donald Berwick
Late last week, President Obama made a recess appointment of Dr. Donald Berwick to head the Center for Medicare and Medicaid Services (formerly the Health Care Financing Administration). This has provided a good chunk of the week and weekend’s polititainment.
I know little about Berwick or his merits as an administrator of the government health care system, but in an April Cato@Liberty post I reviewed an article of his on “patient-centered health care.” If you’re interested, take a look at my comment, “A Little Less Poetry, a Little More Economics.”
“Rahn Curve” Video Shows Government Is Far Too Big
There is considerable academic research on the growth-maximizing level of government spending. Based on a good bit of research, I’m fairly confident that Cato’s Richard Rahn was the first to popularize this concept, so we are going to make him famous (sort of like Art Laffer) in this new video explaining that there is a spending version of the Laffer Curve and that it shows how government is far too large and that this means less prosperity.
Prof. Krugman Is Wrong, Again
Prof. Paul Krugman asserts in his New York Times column of May 31st that “Both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea — not only does it deepen the slump, but it does little to improve the budget outlook, because much of what governments save by spending less they lose as a weaker economy depresses tax receipts.”
While Prof. Krugman and most other fiscalists believe this to be self-evident, it is not. Indeed, this fiscalist dogma fails to withstand the indignity of empirical verification. Prof. Paul Krugman’s formulation fails to mention the state of confidence. This is an important oversight. As Keynes himself put it: “The state of confidence, as they term it, is a matter to which practical men pay the closest and most anxious attention.”
By ignoring the confidence factor, economic theory can lead to wildly incorrect conclusions and misguided policies. Just consider naive Keynesian fiscal theory — the type presented (as Prof. Krugman notes) in textbooks and embraced by most policymakers and the general public. According to Keynesian theory, an expansionary fiscal policy (an increase in government spending and/or a decrease in taxes) stimulates the economy, at least for a year or two after the fiscal stimulus. To put the brakes on the economy, Keynesians counsel a fiscal contraction.
A positive fiscal multiplier is the keystone for Keynesian fiscal theory because it is through the multiplier that changes in the budget balance are transmitted to the economy. With a positive multiplier, there is a positive relationship between changes in the fiscal deficit and economic growth: larger deficits stimulate growth and smaller ones slow things down.
So much for theory. What about the real world? Suppose a country has a very large budget deficit. As a result, market participants might be worried that a further loosening of fiscal conditions would result in more inflation, higher risk premiums and much higher interest rates. In such a situation, the fiscal multipliers may be negative. Fiscal expansion would then dampen economic activity and a fiscal contraction would increase economic activity. These results would be just the opposite of those predicted by naive Keynesian fiscal theory.
The National Debt Is Huge, but Unfunded Liabilities Are America’s Real Red-Ink Challenge
I frequently argue that government spending is the problem, not budget deficits. Regardless of whether it is financed by taxing or borrowing, every penny of spending diverts resources from the productive sector of the economy. I narrated a video explaining why excessive spending is bad from a theoretical perspective. I did another looking at the empirical evidence for smaller government. And I had another video discussing why deficits are a symptom and the real problem is bloated budgets.
Nonetheless, some people seem convinced that deficits and debt are the real problem. While I think that focus is a bit misguided, I certainly agree that there is something utterly immoral about spending today and imposing a fiscal burden on future taxpayers (especially since so much government spending is for current consumption and transfers).
But here’s some really depressing news for the anti-debt crowd. Today’s deficits and debt actually are just the tip of the iceberg. Here’s a new video exposing the enormous unfunded liabilities resulting from entitlement programs. As the video explains, unfunded liabilities are promises by politicians that impose enormous long-term obligations for more spending and debt.
The narrator of the video is Kelly McDonough, a student at American University and a former Cato Institute intern. If this video is anywhere near as successful as the other video narrated by a former Cato intern, perhaps this will become a new tradition. That won’t be good for my video career, but it shows that the Cato Institute is doing a good job cultivating a new generation of freedom fighters.
Monday Links
- Countdown: A quick rundown of some of the best (and worst) ideas for health care reform.
- The case for high-deductible health insurance: “Of every dollar spent on health care in this country, just 13 cents is paid for by the person actually consuming the goods or services….As long as someone else is paying, consumers have every reason to consume as much health care as is available….This all but guarantees that health care costs and spending will continue their unsustainable path. And that is a path leading to more debt, higher taxes, fewer jobs and a reduced standard of living for all Americans.”
- McDonald v. Chicago: A new Supreme Court battle over the right to bear arms.
- Reality: The real housing crisis was the bubble, not the bust. “Washington must stop and re-learn basic economics. First, when you’re in a hole, stop digging. In the case of housing, as a country, we built too much. The cure is to build less.”
- Podcast: “Charge Back, Forward on Financial Regulations” featuring Mark A. Calabria.
Federal Job Creation
The board game Monopoly first took off during the Great Depression. A different game has become popular during today’s Great Recession. In this game, politicians race against high unemployment to create jobs in order to save their own. The players (politicians) have unlimited tax and borrowing authority, and can call upon friendly economists to help them maneuver. The players even get to keep score, although the media can penalize shoddy scorekeeping. Ultimately, voters will decide which players win and lose in the fall elections.
Okay, I’m being facetious. But as politicians continue to throw trillions of dollars at the economy in a vain effort to create jobs, and the media continues to go along with it by obsessing over meaningless job counts, the entire spectacle has become surreal. If government job creation is a game, the losers have been the taxpayers underwriting it, as well as the employers (and their employees) who are closing shop, laying off workers, or not hiring because of uncertainty over what big government schemes will be next.
Two news articles point to this “regime uncertainty” being generated by Washington.
Don’t Trust Economists
Sometimes a picture really does tell a thousand words. Here’s a chart, based on data from the Philadelphia Fed, showing actual economic results compared to the predictions of professional economists. As you can see, my profession does a wretched job. Comparisons based on predictions from the IMF, OECD, CBO, and OMB doubtlessly would generate equally embarrassing results. This does not mean economists are idiots (insert obvious joke here), but it is an additional reason why Keynesianism is misguided. If economists are unable to predict what’s going to happen with the economy in the near future, why should we expect anything positive when politicians tinker with short-run economic performance? That’s especially the case when they pass so-called stimulus legislation that increases the burden of government spending.
This doesn’t mean that economists – and others – are never accurate with predictions. But I am quite confident that we will never see an economic model that successfully predicts future economic fluctuations.
h/t: James Montier, via Paul Kedrosky, via Andrew Sullivan
Monday Links
- How the European Union can bring peace to the Middle East.
- Nat Hentoff on the health care debate: “We do not elect the president and Congress to decide how short our lives will be. That decision is way above their pay grades.”
- Video: What can autism teach us about economics?
- Cato’s Malou Innocent debates the troop build up in Afghanistan.
- Over at Cato Unbound, experts discuss the positive and negative outcomes of modernity.
- Podcast: Driverless cars? They aren’t as far away as you think.
CBO, the Wizard of Oz, and the Keynesian Fairy Tale
The Obama Administration said that the so-called stimulus was necessary so that the unemployment rate would not rise above 8 percent. Indeed, the White House warned that the joblessness rate would climb to 9 percent if lawmakers did not approve the $787 billion package. Critics responded by explaining that making government bigger would divert resources from the productive sector of the economy and hurt growth. These skeptics also noted that nations using “Keynesian” policy, such as the United States in the 1930s and Japan in the 1990s, did not generate good results. And since the unemployment rate is now above 10 percent, it certainly seems like opponents were correct.
But now the supposedly non-partisan Congressional Budget Office has jumped to the defense of the White House, estimating that the spending bill actually generated beween 600,000 and 1.6 million jobs. How can that be, you may ask, when the number of jobs has fallen by more than 3 million? The CBO neatly sidesteps that real-world concern by moving the goalposts, using a slightly more sophisticated version of Obama’s “jobs created or saved” alchemy. Their jobs-created estimate is compared to a make-believe baseline of how many jobs there would be “without the law.”
CBO estimates that in the third quarter of calendar year 2009, an additional 600,000 to 1.6 million people were employed in the United States, and real (inflation-adjusted) gross domestic product (GDP) was 1.2 percent to 3.2 percent higher, than would have been the case in the absence of ARRA. …CBO’s current estimates differ only slightly from those CBO prepared in March 2009. At that time, CBO projected that in the third quarter of 2009, U.S. employment would be higher by 600,000 to 1.5 million people with ARRA than it would be without the law, and real GDP would be 1.1 percent to 3.0 percent higher. CBO’s new estimates reflect small revisions to earlier projections of the timing and magnitude of changes to spending and revenues under ARRA. …Economic output and employment in the spring and summer of 2009 were lower than CBO had projected at the beginning of the year. But in CBO’s judgment, that outcome reflects greater-than-projected weakness in the underlying economy rather than lower-than-expected effects of ARRA.
Needless to say, this means there is no objective benchmark. The unemployment rate could jump to 15 percent and total job losses could reach 10 million, but CBO would continue to say, for all intents and purposes, that the results from their Keynesian model are more important than any real-world numbers. This is the fiscal policy version of the Wizard of Oz, and we’re supposed to ignore reality just as Dorothy and friends were supposed to ignore the man behind the curtain.
To be fair, there is nothing inherently wrong with CBO’s methodology. Economic analysis frequently requires people to make assumptions about how the world would behave with or without a certain policy. So the real question is whether Keynesian economics makes sense from a theoretical perspective, whether there is any supporting evidence, and whether there are more compelling alternatives. Click the links and decide for yourself.
Greedy Local Politicians Attempt to Grab Revenue Far Outside Their Borders
Regular readers of this blog are familiar with the tax competition battle, which largely revolves around high-tax governments attempting to track — and tax — economic activity that migrates to lower-tax jurisdictions. But this is not just a global fight between decrepit welfare states such as France and fiscal havens such as the Cayman Islands. American states also compete with each other, and there are numerous examples of high-tax states such as California and New York trying to grab money from people who escape to zero-income tax states such as Nevada and Florida. The fight even exists at the local level, and a good example is the attempt by politicians to tax faraway online travel agencies. The Orange County Register opines about these extraterritorial tax grabs:
A recent legal victory for some Texas cities against online travel companies over hotel taxes may have given Anaheim officials hope for their own case, but they shouldn’t start celebrating just yet. Other cities have not fared as well in similar lawsuits. …Here’s what Fairview Heights, Anaheim and other cities wanted to change: In a typical transaction, a traveler picks a hotel and books a room, stays there, and pays the hotel a room charge plus a local occupancy tax based on the room charge. The hotel keeps the room charge and forwards the tax money to the government. Enter online travel companies like Expedia, Hotels.com, Orbitz, Priceline and Travelocity, which allow travelers to sort through hotels and book a room on a central Web site. These companies do not reserve or resell hotel rooms, but act as intermediaries to facilitate the transaction between hotel and traveler. The hotel receives an amount for the room, on which the city’s hotel tax is based. Let’s say I search a Web site and book a $100 hotel room. The online company charges me $10 for their service. Anaheim argues that hotel occupancy tax should be paid not only on the $100 room charge, but also on the $10 service fee. …A federal bill is pending to limit hotel taxes to amounts collected by a hotel for occupancy purposes, excluding service fees and markups by intermediaries. The Constitution permits Congress to pass such laws if there is a danger that state and city laws are interfering with interstate commerce. Hotel taxes are attractive to local politicians because they are a way to shift the tax burden to “outsiders.” But because every U.S. city has a hotel tax, we’re all somebody else’s “outsider.” The net result is that everyone is taxing everyone else in an unaccountable way, and unless the cities and their lawyers are stopped, in an unpredictable way, too.
Even Obama’s Make-Believe Jobs Are Not Real
The White House recently began claiming that the “Recovery Act” had “created or saved” 640,000-plus jobs. This turns out to have been a political mistake, in part because even sympathetic reporters understand that the “jobs saved” measure allows for creative accounting. But the White House also erred by providing (supposed) details about the jobs that were created. This made it very easy for reporters and other curious people to do a bit of fact checking, which has generated a spate of stories showing that the White House’s numbers are wrong, even using make-believe methodology. The Washington Examiner has put together a very useful interactive map which links to many of the news reports debunking the Administration’s fraudulent numbers.
Cato on Facebook
Cato on Twitter
Cato on Google+
Cato on YouTube
