Site Meter

Thursday, January 29, 2015

QOTD Josh Barro

A ‘Rich’ Person Is Someone Who Makes 50 Percent More Than You ... @UpshotNYT NYT - Josh Barro - Jan 29
The first rule of modern tax policy is raise taxes only on the rich. The second rule is that your family isn’t rich, even if you make a lot of money.

Wednesday, January 28, 2015

On Glasner on the Long Run Phillips Curve

David Glasner has another interesting post questioning Milton Friedman's immense status. This time he asserts that the claim that the long run Phillips curve is vertical does not have implications which are useful to policy makers or macro econometricians. I think it is best to just click the link rather than trust my effort to summarize.

I comment

I entirely agree. I think the practical and empirical irrelevance of the long run Phillips curve helps us understand how it came to be believed that old Keynesians (I am thinking Solow, Samuelson and Tobin) contested Friedman's claim. In fact, in everything by them which I have read (which isn't close to everything that that they wrote) they agreed with his argument and conclusion, then went on to say that it didn't offer much guidance to policymakers or econometricians. That is, they made your point (again and again). They are considered to be very smart, but not for making that obvious but important point again and again.

Now the fact that 4 such economists agree should convince me. But I beg to differ with all 4 (see below for qualifications). The argument relies on the assumption that there is a unique equilibrium unemployment rate. It is assumed that cyclical unemployment can't become structural or, in modern jargon, that there is no hysteresis. The existence of a natural rate of unemployment which is also the NAIRU is an article of faith. There isn't much evidence in this continent (Europe) for any such thing. Friedman's obvious and convincing claim is that forecast errors can't have the same sign indefinately. The assertion that deviations of unemployment from the natural rate are all due to forecast errors and nothing else anticipates so called new Keynesian macroeconomics and still dominates the profession. However, it was not argued or defended and has been challenged by decades of European data. Samuelson and Solow discussed this issue in their 1960 AEA talk on the Phillips curve. I'm sure Tobin discussed it a lot. But somehow hysteresis is found when economists look for it then assumed away when they advise policy makers.

The phrase "the long run Phillips curve" has content even without the possible additional words "is vertical" or "slopes down". The phrase asserts that there is no hysteresis. It asserts that forecasts for unemployment and inflation in the distant enough future must lie on a curve -- that the set of equilibria is one dimensional. With extreme enough hysteresis the set of equilibria would be limited only because the unemployment rate must be between 0 and 100%. Such a model would be crazy, but the assertion that the set equilibria is one dimensional is an assumption not a result.

Monday, January 26, 2015

On Coppola on [spoiler alert]

Discussing Syriza, Frances Coppola quotes Keynes who she names only at the end of the column (although she knew and wrote that it would be easy to guess who it was).

Some snippets

Keynes on how to achieve recovery

or public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money. [skip] "Thus as the prime mover in the first stage of the technique of recovery I lay overwhelming emphasis on the increase of national purchasing power resulting from governmental expenditure which is financed by Loans and not by taxing present incomes. Nothing else counts in comparison with this.
I dare to comment on Keynes.

Keynes hadn't arrived at The General Theory (1926) yet, or, at least, he hadn't arrived at Hicks (1937). In the IS-LM model, increased public spending causes increased aggregate demand even if it is financed through increased taxes. Deficit spending has a larger effect, but balanced budget spending increases have a positive multiplier (equal to 1 if the economy is in a liquidity trap).

Coppola explains "What exactly was Keynes criticising in this letter? It was FDR's National Industrial Recovery Programme: "

Coppola on Keynes and Krugman

And I'm sorry, Professor Krugman, but he doesn't have much time for arguments that deliberately raising inflation will magically restore output, either:

there is much less to be said in favour of rising prices, if they are brought about at the expense of rising output. Some debtors may be helped, but the national recovery as a whole will be retarded. Thus rising prices caused by deliberately increasing prime costs or by restricting output have a vastly inferior value to rising prices which are the natural result of an increase in the nation's purchasing power...... ......too much emphasis on the remedial value of a higher price-level as an object in itself may lead to serious misapprehension as to the part which prices can play in the technique of recovery. The stimulation of output by increasing aggregate purchasing power is the right way to get prices up; and not the other way round".
I comment

You are a bit hard on Krugman who would not advocate a National Industrial Recovery Act (I don't know of any economist who thinks it was a good bill). Increased inflation due to promised loose money in the future is quite different.

Also the data from 1933-4 tend provide some support for FDR versus Keynes round one (as the data from 1937-8 overwhelmingly support Keynes v FDR round two). Notably deflation ended and investment levels suggest expected inflation increased sharply. Many (including especially Christina Romer and often Brad DeLong) assert that this must have been due to the US going off the gold standard. But the NIRA aimed to cause this to happen, then it happened. The NIRA involved meddling with the price mechanism (indeed allowing and encouraging anti competitive practices). It is generally detested (also by me). But the few data points of evidence correspond to the hopes of those who enacted it.

On Glasner on Friedman on Phillips

David Glasner has a very interesting post in which he discusses the question of whether David Hume came up with the argument that the long run Phillips curve is vertical or just with the idea that there is a Phillips curve.

In it, he argues that Friedman and Phelps's expectations based critique of the Phillips curve was not original. That sets me off on the usual which is a comment over there and reproduced here.

I very much agree with your claim that Friedman 1968 did not introduce the expectations critique of the Phillips curve. In fact the argument was made repeatedly before Phillips graphed his scatter plot, James Forder wrote a working paper on this

in which the expectations argument is made quite clearly by, among many others, Friedman in 1958, Simons in 1936, Samuelson and Solow 1960 and Hicks in 1967. Simons and Hicks pretty clearly state the view that the long run Phillips curve is vertical.

By the way, while there is overwhelming evidence against an expectations unaugmented Phillips curve, there is not overwhelming evidence that the long run Phillips curve is vertical. If there is downward nominal rigidity, then there can be a sloping long run Phillips curve (Akerlof GA, Dickens WT, Perry GL (1996) The Macroeconomics of Low Inflation [including comments by Gordon and Mankiw]. Brookings Papers on Economic Activity, 1996(1):1-59 [60-76]. Notably, in recent years US inflation and unemployment have fallen on what sure looks like an expectations unaugmented Phillips curve.

There are two separate issues -- is the slope of the long run Phillips curve as low as that of the short run Phillips curve (answer definitely not) and is the long run Phillips curve vertical (this does not follow). Importantly, Friedman argued convincingly that it was impossible to keep unemployment below the NAIRU. It doesn't follow that it is impossible to keep it slightly higher. If there is a range of unemployment over which inflation decelerates to zero, but not below (because of downward nominal rigidity) then unemployment can stay at any point in that range. For example what if with unemployment less than 5% one has accelerating inflation but unemployement must be greater 8% to cause actual deflation. In that case, one can have zero inflation with unemployment at any level between 5% and 8%. Thus far the Phillips curve has a horizontal part. The downward slope comes from having many local labor markets.

In any case, data from the 1970s do not prove that the long run Phillips curve is vertical. Empirical point estimates never had coefficients on lagged inflation adding up to one (unless this was imposed based on Friedman's theoretical argument).

On the other hand, David Hume definitely presented the quantity theory of money. I have no idea if he came up with the permanent income hypothesis.

Friday, January 23, 2015

Reading James Forder

I am actually reading "Macroeconomics and the Phillips Curve" by James Forder. I started in the middle after searching for [Samuelson incomes policy]. I shall go to and honestly pay, although I am currently reading a google book. I decided to read the whole thing and learned something on the first page. It seems that, like the quantity theory of money, the Phillips curve was first discussed by David Hume.
So the great macroeconomic debate of the 60s was Hume vs Hume. It is impressive that his disciple Adam Smith had interesting things to add. Pity so few of their successors did.

Wednesday, January 21, 2015


I typed something sloppily which stimulated Nick Rowe (see his comments here)
Actually I have a challenge. Name a Friedman Solow debate which, with the benefit of hindsight, we agree was won by Friedman. I do not think this is easy to do.
The problem, I think, is the word "we". My challenge was to name a Friedman Solow debate and convince me (Robert Waldmann) that Friedman was right. Rowe interpreted "we" to refer to the main stream of the macroeconomics profession. For that set of people I use the pronoun "they" and I don't agree with them on much.

Of course, no one much cares what I think. However, I do think I have an interesting question. Let's take it as agreed that new Keynesian macroeconomics is basically Friedmanite macroeconomics and both are very different from old Keynesian macroeconomics and real business cycle theory. Now clearly new Keynesian has replaced old Keynesian in the academy and, in that sense, they have won something rather like a debate. However, I think this victory came in one of two ways.

First there was the victory over the straw man of the expectations unaugmented Phillips curve. I think the conventional recollection of that alleged debate is almost entirely fictional. Basically google James Forder Oxford or click here , here, here,here here here. But it really is better to google James Forder Oxford. I haven't read the book, but I have read a lot of his working papers.

I definitely call this one for Samuelson and Solow 1960. Yes the profession (also over here with huge persistent unemployment) believes in the natural rate hypothesis. The profession is crazy.

The permanent income hypothesis is no longer controversial or a hypothesis. It is rejected by the data and no one cares. It is now the permanent income model and it is assserted that although it isn't true it may be useful (the logic is almost that since it isn't exactly true it must be useful). I asked if there is anything useful about the permanent income model. I didn't get a definite yes from any data. here here here here

There is the idea that AD should be managed with monetary policy. I do not do not want to go there. I just note that recent experience doesn't show that good monetary policy solves AD problems. It can be argued that it is because we haven't had good monetary policy. In contrast, there is strong evidence that expansionary fiscal policy (as in China) works, that modestly expansionary fiscal policy (the ARRA in the USA) works moderately and that austerity has terrible consequences. I think the weight of evidence is very strongly against the idea that the best way to manage AD is always monetary policy. I note that part of the Friedman vs Old Keynesian debate was whether liquidity trapping was possible. Friedman argued no. I think the debate should be considered settled (of course I know it isn't considered settled).

Floating exchange rates may beat the alternative, but the idea, which I ascribe to Friedman, that they won't fluctuate widely with associated huge current account surpluses and deficits is now known to be false. Also I vaguely recall reading an Newsweek column by Samuelson about who cares about the current account deficit which we can ban permanently by floating the exchange rate (needless to say, he was wrong, the point is that I think he agreed with Friedman). This is a recollection of something written in the early 70s (when I was in my early teens) which can't be googled.

Rules v discretion in monetary policy. Has anyone noticed that the FOMC is not working according to a rule ? Here I think market monetarists argue that something should be done and would work fine.

Anyway, Rowe and I agree that Friedman dominates mainstream (non RBC) macro. But he seems to think that this is the result of some sort of inquiry which might be construed as scientific. I think it is based on almost universal almost utter contempt for the evidence.

update: I see I have gotten off topic. I should have stuck to the challenge of finding some point where Solow clearly disagreed with Friedman and subsequent data strongly support Friedman. Solow Importantly, I am not discussing Solow's (massive) original contributions -- if Friedman said something first, and Solow agreed, then they didn't debate.

I can think of two debates. One alleged and very famous debate was about the Phillips curve. However, recollections of Solow's position are inconsistent with what he actually wrote. I see two points where Solow disagreed with Friedman. First, in current terminology, Solow argued that inflation expectations were sometimes anchored (sometimes as in not in Latin America in the 60s). Here, current discussion seems to me to follow Solow almost exactly. Second, Solow discussed cyclical unemployment becoming structural. This is now called hysteresis. As far as I know, Friedman didn't consider the issue. It seems to be quite important. Anyway, on the PIH debate, I suggest the reader (if anyone is still reading go to James Forder at Oxford).

On the PIH, Solow dismissed Ricardian equivalence. Friedman didn't use the phrase, but he clearly appealed to the concept. I think the evidence on this point is very clear.

This post is a reply to Rowe comments on an older post. Also in comments to that post, Alan Marin wrote something I was groping towards above

Finally, for now at least, I think that on the crucial Rules vs. Discretion 1970s disagreement between Friedman and the Keynesians, current practice fits neither exactly, but is closer to the Keynesians. Nick Rowe overstated the Friedman "victory" by ignoring the distinction between instruments and targets. Steady inflation is now viewed as a target, but Central Banks are given full discretion over their use of the instrument. This is very different than a Friedmanite rule of a steady increase in the quantity of the monetary base [*]. Central Banks do not even commit to an explicit unvarying Taylor Rule, which would have been closer to a Friedman type of rule. Simiilarly, CB monetary policy does not take Friedman's view that the lags in the effects of policy are so long and variable as to make any response to current events undesirable.
* update: See Nick Rowe in comments again ! The Friedman rule was k% growth of money not of monetary base. This means that during the brief period they tried to follow a Friedman rule, the FOMC had to monitor the money multiplier (IIRC M2 divided by Fed liabilities) and perform open market operations.

Vague Thoughts on Double Taxation of Dividends

Reader beware. This is economics but it isn't my field of expertise. There is a huge literature on the effects of double taxation of dividends which I haven't read.

Dividends are taxed first as corporate income then as personal income of shareholders. In contrast, interest paid by the firm is counted as a cost and subtracted when calculating (and taxing) corporate income. Economists have long argued that this creates inefficiencies. I what I vaguely recall as an actual effect of economic theory on policy, if I understand correctly, Glenn Hubbard convinced George Bush to propose the eventually enacted dividend tax cut of 2003 (see line 9b of your friendly 1040 income which isn't included in the sum of taxable income).

Mike Konczal and Brad DeLong suggested we read a (pdf warning) paper by Danny Yagan which asserts that the tax cut did not have the desired effect (I admit I have read only the abstract).

I am trying to remember the logic of the tax cut. Now of course the tax cut was encouraged by the general view that capital income of all sorts not be taxed. If income is equally distributed already or if one doesn't care about income distribution, this view makes sense. Also even if one cares about income distribution and capital income mostly goes to the rich the optimal tax on capital income goes to zero as time goes to infinity. I wrote a little model in which the tax should be zero after all inequality has been eliminated and as high as can be collected until then (warning PDF which was very kindly and heroically constructed by Sigve Indregard whom I have never met — isn’t the internet wonderful). There is certainly no case for cutting taxes on capital income now leading to accumulated debt causing higher taxes on capital income in the future - the result is that the tax rate should decline over time.

However, there is also the issue of debt vs equity. Here the tax affects decisions to issue and retire shares. At least in the standard model used by macroeconomists a fixed number of firms exist and they maximize the present value of dividends net of taxes. A constant flat tax on dividends doesn't distort their decisions -- it is a tax they have to pay sooner or later. In this model, imagine imposing a 50% dividend tax on firm A but not firm B. The shares of firm A would lose half their value. Nothing else would change. The tax would have no effect on investment or employment.

Obviously the silly simple model leaves almost everything out.

How about initial public offerings ? There aren't any in the standard simple macro model. They are important. The amount raised with an IPO is greater if dividends aren't taxed. This means more low cost internal financing for new firms with good prospects. This means greater financial rewards for entrepreneurs. Now if we cares only about IPOs the tax cut is poorly targetted -- it would better to subsidize IPOs directly. However, one might hope that the 2003 reform caused an increased rate of IPOs. I don't know what happened to the rate of IPOs from 2003 to 2004. I use the Google and find (pdf) "Where Have all the IPOs Gone ?" by Gao Ritter and Zhu. Oooops doesn't seem to have worked.

Going the other way, favoring debt over equity encourages debt financed mergers and leveraged buyouts. This is a distortion. The causal channel is simple -- the tax cut should have caused higher share prices which makes debt financed takeovers more costly. So what happened ? I ask the google again which sends to to the Wikipedia which has an article on LBOs with the section "The third private equity boom and the Golden Age of Private Equity (2003–2007)" oops.

I stress I am not assuming LBOs are bad or that IPOs are good. The assumption is that if something is done to reduce tax liabilities, the tax is causing dead weight losses.

Double taxation of dividends favors debt. This can lead to financial fragility -- one possible benefit of the 2003 tax cut would be reduced bankruptcies -- ooops.

I honestly didn't know what Google just told me. It sure looks as if the aggregate trends are the opposite of those expected by advocates of the 2003 tax cuts.

I am sure no one is convinced by looking at the time series of IPOs LBOs and bankruptcies. There aren't enough data to prove anything. A whole lot of things are going on. However, I don't see a practical alternative. The issues are the creation and destruction of publicly listed corportations. They can't be addressed by looking at a panel of firms.

In any case, I found no evidence at all that the tax cut had the expected effects.

Tuesday, January 20, 2015

On Smith on Rowe on Krugman on Friedman

Nick Rowe wrote a post "There are no Friedmans today, except maybe Friedman himself" which I admit I haven't read.

Rowe declared Milton Friedman the victor of, at least, the macroeconomics debate. Without reading his post, I thought (and commented at Brad Delong's blog) that the battle isn't over and that the other than Friedman forces are currently winning back lost ground. In other words, I agree with Rowe (and an earlier post by DeLong) that Friedman's thought is the main stream of macroeconomics, although it is, oddly, called new Keynesian.

Noah Smith has 5 excellent questions for Nick Rowe. Do read Smith's post (for one thing he has read Rowe's post). My comment

As usual, I think this post is excellent (I guess I should save pixels by leaving that part out).

I definitely agree that mentioning Marxists is a bit odd. Marxist economists were marginal in the 70s. I don't think it makes sense to use the same word for Keynesians and Marxists together at all.

I do not recall widespread support for price controls among mainstream left of center economists. I definitely do recall hearing Robert Solow say that, while he doesn't have any strong ideological fixation on free markets, wage and price controls are just bad policy. Here (and always) I think that claims about what was generally said and written should be ruled out of order unless backed by names and citations. I personally recall hearing what Solow said on the topic in a Kennedy School public debate on what to do about high inflation. Update: Nick Rowe in comments links to Tobin (see next paragraph). My vague recollection of what I heard from economists when I was a biologist does not seem to be reliably intellectual history. I score this one Rowe 1 Waldmann ... hey I was just blogging at my personal blog and I just asked I didn't assert.

Or to put it another way, I am interested in Friedman vs Samuelson, Solow and Tobin.

Actually I have a challenge. Name a Friedman Solow debate which, with the benefit of hindsight, we agree was won by Friedman. I do not think this is easy to do.

I was alive in the 70s although kinda young and not an economist. I remember almost no discussion of wage and price controls after 1973 (when Nixon who was not Galbraith imposed them).

I recall extensive discussion of whether central banks should target interest rates or the money stock. This is a debate which Friedman won, leading to a shift in the late 70s to targetting the money stock, then lost in around 1982. How often do you read about the quantity of money ? How much did it grow in the past year ? Monetarism wasn't just the claim that monetary policy matters, but also the claim that the quantity of money was the key variable, because velocity is stable and predictable. This, the absolutely central aspect of monetarism according to Friedman, seems to have been conveniently forgotten by March 2008 at the latest. Or to put it another way, Friedman and new Keynesians have a lot in common, but also disagree on something Friedman considered extraordinarily important.

Your point 4 is related to your point 1. Rowe defines the left so that universal health insurance and environmental regulation are not leftist. It isn't as if people far to the left of Friedman ranging from Samuelson to Che Guevara are so similar that it is useful to discuss them together. Friedman, however, definitely advocated deregulationa and a sharp reduction of the state which haven't happened. He and Rose Friedman wrote a book called "The Tyranny of the Status Quo" during the Reagan administration. This is not a title for a book written by someone who won the policy debate (you may correctly guess that I haven't read the book).

Finally, you Rowe and I agree that Friedman dominated academic macroeconomics in 2007 with new Keyenesians better labeled Friedmanites. However, there have been some rather shocking new data since then leading to heated debate and making it a very odd time to try to decide who won the debate.

George Osborne buying votes in the UK

Via Simon Wren-Lewis, Richard Murphy informed me of a genuinely horrible policy in the UK. The Queen's exchequer is selling bonds at a discount to people over 65. As Chris Dillow explains, this gift is being given only to the at least moderately well off, since one must have financial wealth already to buy the special bonds. Wren-Lewis and Murphy have no doubt that this is a very blatant effort to buy votes in the upcoming election.

Murphy explains and denounces

here he [Chancellor George Osborne] is selling debt at 4% when he could quite easily sell it for less than half that price elsewhere. No one has done more to burden future generations than he is as a result. But the tune will not change, I am sure.

So why is he doing this? Candidly, it’s little better than gerrymandering. He’s literally selling the government’s silver to buy votes form the over 65s. Bribery is the nicest and politest possible term for his policy. I can't help focusing on one very odd thing Osborne said "Our long-term economic plan involves supporting savers. "

First he conflates a lump sum gift with an incentive scheme. At some times, there might be be good reason to encourage saving, but giving a surprise gift to those who have saved suggesting that it might happen again is a very inefficient incentive scheme. second, this is not one of those times. The UK has higher than NAIRU unemployment (now 6%) and 1.2 % inflation with interest rates at the zero lower bound. It could use more consumption not less. Osborne has found a way to add to the debt in the future (when debt will crowd out investment) and (he claims) encourage lower consumption in the present (when consumption won't crowd out investment). Finally, as a conservative, he identifies wealth with thrift. Savers differ from people who had equal income but spent more, but also from people who had much lower income and spent less. The conflation of wealth and thrift is deeply conservative. There is a lot of nonsense packed in that one short sentence.

Wren-Lewis is optimistic that Osborne has gone so far that the media will have to notice that he is a hypocrite. In fact, the giveaway was denounced by the conservative TaxPayers' Alliance

Campaigns director Andy Silvester said: "They're not only taxpayer-guaranteed investments for the already relatively well-off, but leave the government borrowing at above-market rates. "Too often during this Parliament it has seemed as if austerity stops at 65 - it's almost as if pensioners are more likely to vote."
I defer to Wren-Lewis's expertise and also guess he is totally right. Osborne had a reputation for severe integrity (he had the severe part down in any case). Now he has revealed himself to be a vote buying hypocrite. I imagine or at least fantasize that now that the mask has dropped, people won't be fooled again when Osborne puts it back on.

There is a pattern of assuming that austerians are honest. US reader(s) will recall the case of high praise of the integrity of the extremely dishonest Paul Ryan. Italian reader(s) will note that the austerian wonk Giulio Tremonti (who managed the Italian budget and economy while Burlusconi focused on staying out of jail and bunga bunga) is being investigated for allegedly taking a huge bribe (Italian politician's (alleged) dishonesty is, I admit, in a different league). I wonder if people might some day realize that enthusiasm for cutting government spending (especially anti poverty spending) is not proof of honesty.

Saturday, January 10, 2015

20 posts on 20 points ?

I have tried and failed to resist risking wasting reader's* time with another post on the same 20 data points. I am still looking at US fiscal policy and GDP growth during the current recovery. I first looked at government purchases (G) and GDP. Commenters note that Keynesians talk about deficit spending.

One not totally pointless point is that New Keynesians talk about G minus steady state G in theory (which means G minus some sort of trend in data). The work horse NK models have Ricardian equivalence so the timing of taxes doesn't matter.

But I am a paleo Keynesian, so I should look at something else. I should look at G-cT where T is taxes minus transfers (such as pensions) and c is the marginal propensity to consume which I have estimated to be about 1/3. Note that this is not at all equal to the deficit G-T. It is true that Keynesians have used the full employment (or "structural") deficit as a fiscal policy variable, but this never made sense for any Keynesian model (including the original IS-LM dated 1937).

Being totally lazy, I look at real G + 0.5 times the Federal budget deficit divided by the GDP deflator. This means that Federal G appears 1.5 times, state and local G appear 1 time and federal taxes minus transfers appear -0.5 times. I call this variable silly.

The recovery started in 2009q2 and I look at growth rates starting then (with growth from 2009q2 to 2009q3). The correlation between the growth rate of real GDP and the growth rate of silly is 0.22 which is considerable smaller than the correlation of the growth rate of real GDP and the growth rate of real G.

Here is the scatter

The reduced correlation is mostly due to 2013q1. As the US went over the fiscal cliff (even reduced at the last minute) Federal revenues increased sharply. This was not correlated with low GDP growth (or even low growth of consumption by the way). This data point looks Ricardian -- it fits new Keynesian models better than old Keynesian models. It is one data point. Stuff happens. This is my second post about that one data point which bothers me even though it is just one data point.

*this is not a typo. I assume the reader, if any, will be singular.

Wednesday, January 07, 2015

The Fiscal Cliff Multiplier

I am wondering why the fiscal cliff January 2013 didn't have a noticeable effect on the growth if consumption and GDP.

Compared to 2012 policy, the fiscal cliff deal principally consisted of increased taxation of extremely high income and large inheritances. I would not expect this to affect consumption much. However, it also included expiration of the partial payroll tax holiday with an increase in payroll taxes of 2%. This corresponds to a regressive tax increase of $115 billion. A new Keynesian could argue that the timing of taxes doesn't matter, since consumers knew that something like that would happen. But I can't.

A now standard estimate of the government spending multiplier is 1.5. To the most paleo of paleo Keynesians, this should be 1/(1-c) (where c is the marginal propensity to consume) giving c = 1/3. The tax increase multiplier should be c/(1-c) = 0.5 so the impact on GDP should have been about 0.5*115/16768 roughly = 0.4 %

This corresponds to a reduction in the annualized growth rate of 1.6%.

I have a problem. It isn't terrible. The predicted effect is small enough that it could be obscurred by the ordinary fluctuations in quarterly growth rates. But it seems to me that it should have been noticeable.

Moving on from 1937 to the 1960s the second most paleo possible Keynesian notes that increased aggregate demand causes increased investment through the accelerator. A payroll tax increase does not have this effect. The government expenditure multiplier is 1/(1-c-b) where b is the effect on investment, but the tax increase multiplier is still c/(1-c).

I estimate b = 0.29 (this is just from a regression of investment/GDP on the lagged annual GDP growth rate and a trend). I have gone too far, with a c=0.04 and a tiny multiplier.

OK where did I get the 1.5? Well always from looking at papers which look across US states or across mostly European countries. The multiplier for a large almost closed economy like the whole USA should be larger. I will guess 1/(1-c-0.29) = 2 so c is about .2 so c/(1-c) is about 1/4 and the effect on annualized growth about 0.8% which is not tiny but now well within the normal variation of growth rates.

I guess the bottom line of this silly exercize is that we can't learn anything from one data point regressions. I am talking about one quarterly growth rate and there is almost no information in it.

On Sachs on Krugman

cross posted at angrybearblog I have been pinged

and am so flattered to be pinged in such company that I decided I had to read the Jeff Sachs article on Krugman Austerity and the Obama recovery and comment on it. It isn't quite as bad as I feared.

My comment is really here. I note that the actual pattern corresponds to Krugman's descriptio of growth of real GDP speading up exactly when the long decline of government purchases (G) reversed in 2014q2. I fear I will be posted the graph of US real G for the rest of my life.

The graph shows steadily increasing austerity along with consistently disappointing recovery, then an end to the reduction in G and rapid growth. The data perfectly fit both the vulgar Keynesian story and the fancier Krugmanite story that vulgar Keynesianism is valid when the economy is in the liquidity trap.

Krugman's response is extremely convincing. Brad DeLong is impressively shrill. Simon Wren-Lewis found a new way to illustrate the fact that the recovery was disappointing.

So what was Sachs thinking ? First, in his defence, I am sure the "brisk" growth he had in mind was in 2014q2 and 2014q3. He should note that some is the economy unfreazing after 2014q1, but the word isn't crazy.

I think he made one polemical choice and one mistake. The mistake is to consider only Federal fiscal policy. This is a natural simplification if one relies on daily newspapers for news of fiscal policy, but Sachs should know how to FRED and should know to FRED. For aggregate demand, it doesn't matter if government consumption and investment is federal state or local. The graph above is for all together. This mistake is less excusable in a critique of Krugman, as Krugman often discusses the 50 little Hoovers.

Second the polemical choice is to focus on the deficit and not on G. This is totally unreasonable in a critique of Krugman. Krugman has repeatedly stressed the difference between the Government expenditure multiplier and that tax cut multiplier. He denounced Obama for (among many other things) including too largetax cuts as well as too small spending increases in the ARRA (Sachs made the same objection).

Krugman has made a proposal for optimal fiscal policy in a liquidity trap. In it he did not mention the timing of taxes at all, because he used a model with Ricardian equivalence in which this timing doesn't affect aggregate demand. The post is flagged as "ultra-wonkish" but it isn't too wonkish for Sachs.

Importantly, Keynesians all agree that balanced budget spending increases (as proposed by Sachs) stimulate. Therefore the structural deficit is not an adequate index of the fiscal stance. Some New Keynesians go so far as to use models in which deficits don't matter (By my rules I must name names, so I name Smets and Wouters). I consider myself an extremely old fashioned Keynesian who thinks the timing of taxes matters a lot. Krugman and Sachs are somewhere in between, and at almost exactly the same point. Being (even) less enamored of Ricardian equivalence than Krugman, I have more of an intellectual problem due to the absense of noticeable damage due to the end of the partial payroll tax holiday in 2013q1 (this not being the NYT I can just say that is just one data point and that shit happens). Oddly Sachs and Krugman agree on policy, yet Sachs continues to insist that Krugman disagrees.

Thursday, January 01, 2015

we can't learn much from G and GNP during the current recovery

I'm continuing this discussion over here at this obscure blog, because writing 21 posts about 21 data points is a bit embarrassing. I noted that, since the recovery started June 2009, government the quarterly growth of consumption plus investment (G) is positively correlated with the growth rate of GDP. I followed up here. In both of those posts, I mention that this amounts to very weak evidence.


Importantly, Williamson and I agree that simple raw correlations tell us almost nothing especially when there are very few data points. As always, I stress that, to me, the interesting thing is the difference between statistical calculations however simple and crude (people agree on what they are if not what they mean) and impressions based on reading newspapers where people perceive very different supposed facts.
Of course even if one believed the conventionally calculated OLS standard errors (which is crazy) and assume that there are no omitted variables, which is crazy, one would get an +/-2 standard deviation interval from 0.248 to 3.184 so basically I totally misled the computer about the data generatingprocess but it still understands that 19 data points can’t prove or disprove anything.
Here 19 not 21 as FRED hadn't yet reported 2014q3 GDP and I used only changes t to t+1 where t as well as t+1 are during the recovery so didn't use 2009q2-2009q3.

I just want to explain more thoroughly why a simple correlation of 21 growth rates tells us little. First, and most importantly, many things other than G affect GDP. It is not possible to consider many variables with only 21 observations, so there is no solution to the problem. One way to see this is to look at the correlation starting at the peak 2007q4 not the trough 2008q2 (as I forget who on the web did -- sorry for no link tell me who you are in comments). For this sample, the correlation is strongly negative. Now this excludes the deflation of a housing bubble and a financial crisis, so it isn't convincing evidence that G causes lower GDP. But it does focus the mind on the risk that there are less obvious ommitted variables which explain GDP changes during the recovery.

Second and less importantly, there can be reverse causation. It is possible that high GDP growth causes high G growth. G is generally modified as exogenous and shifting due to the mysterious whims of policy makers, but state and local governments have limited authority to run deficits so low GDP growth causes pressure for low state and local spending growth. I don't think this is a big deal in quarterly data, but it is an issue.

Finally the standard errors and t-statistics are definitely nonsense. They are calculated under the assumption that disturbances are identically normally distributed and uncorrelated. They aren't, so the conventional standard errors are nonsense. This isn't always such a huge issue if large samples of data are used, but a set of 21 observations is small.