State and Local Employment and Spending Trends

In a recent Economix post, Casey Mulligan asserts that aid to the states and localities is unwarranted given that state and local government employment is doing just fine. His graph highlighting cumulative gains/losses ends in January 2009, to show what had transpired by the time the stimulus bill was being debated. How do things look if one extends the sample to August 2009? And what about spending as opposed to employment?

Figure 1 depicts the level state and local employment. The two dashed lines indicate the reference dates in Professor Mulligan’s comparison.
slemp1.gif

Figure 1: State and local government employment, in thousands, seasonally adjusted. Dashed lines refer to begin-end dates used in Mulligan’s graph. Gray shading denotes NBER defined recession dates assuming trough at June 2009. Source: BLS, Employment Situation August release and NBER.

Using those two reference dates, state and local employment has indeed increased. And in fact, the level of employment in August is still above that in December 2007 (but only by 43,000 higher, instead of the 110,000 cited by Professor Mulligan for July — I think I see a trend). However, I think gradients are of even more interest, and looking at y/y and q/q annualized growth rates, one sees that currently employment is falling. This is highlighted in Figure 2.
slemp2.gif

Figure 2: Year-on-year growth rate in state and local government employment (blue), and quarter-on-quarter annualized growth rate (red), calculated as log differences. Dashed lines refer to begin-end dates used in Mulligan’s graph. Gray shading denotes NBER defined recession dates assuming trough at June 2009. Source: BLS, Employment Situation August release, NBER, and author’s calculations.

So, I’m willing to say public policy types were able to see the handwriting on the wall, note that in the future that state and local tax revenues would decline, and in the absence of countervailing action, would have to cut employment deeply.

 

Moving from the statistics, there are some odd arguments in the post. After observing the relative losses in the private vs. state/local sectors, he concludes:

For these reasons, an effective stimulus law would have allocated state and local government something from 4 percent (its share of layoffs) to 14 percent (its share of employment) of its funds.

I’ll just make two observations: (1) we have government employment partly because of externalities/public goods arguments (the private sector underprovides police officers, fire fighters, etc.), and (2) not all the funds given to the states is used to pay government workers. In fact, as noted by a recent GAO report some had been used to undertake road repairs, which entailed hiring private construction contractors (Professor Mulligan has stressed underutilized resources in construction in the past).

 

As opposed to looking at employment, one could look at what government spending at the state and local level was doing just before the stimulus bill kicked in.
slemp3.gif

Figure 3: Quarter on quarter annualized growth rate of state and local government spending (blue, left axis), and level, Ch.2005$ SAAR (red, right axis). NBER defined recession dates shaded gray, assuming trough at 2009Q2. Source: BEA, 2009Q2 second release, and author’s calculations.

It’s clear that state and local real spending on goods and services was tanking in 2008Q4 and 2009Q1. It picked up in 2009Q2; most reasonable people agree that in the absence of the transfers to the states, spending would have been lower.

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22 thoughts on “State and Local Employment and Spending Trends

  1. Young Economist

    I think government should focus on the long term policy issue rather than short term stimulus policy. Now economy is back to normal with increasing economic growth, strong investor from rising stock prices, commodities prices and the strong expectation on rising price from ISM-price paid index. This means we are normal and maybe more than normal because ISM-Price paid index shows the very high inflation. Meaning that all stimulus policy both fiscal and monetary policies will affect only price now from the current expectation. Surely, we will have the high inflation and this will kill economy and create the instability in the economy. We face a lot of bubbles and crashes and governments are prone to growth policy rather than long-term policy from stability and now we have Tech bubbles, Subprime bubbles and we have only rising unemployment with higher cost of living. We cheat the unemployment rate that we change methodology; so we have 9.7% rather than 16% from we used to have 3%. How can we call this is the right policy? I think if all policy makers do not change their views to focus long term problems such as low saving rate, over-consumption, over-debts, rising aging people, healthcare problems, uncontrollable budget debts and deficit. We will have only high unemployment with high cost of living at the end and this is from the wrong policy from short-term growth rather long-term growth with stability.

  2. DickF

    A history lesson.
    In 1947 Herb Stein, Keynesian Chairman of Richard Nixon’s Council of Economic Advisors developed the “full employment budget concept.” In summary the concept was that the federal government excelled at tax collection, states excelled at government spending. The Keynesian tax policy (used by Kennedy) was inefficient. If congress was encouraged to lower taxes they would lower too much creating an overheated” economy, but if congress was encouraged to increase taxes they would drag their feet allowing inflation. A better Keynesian idea, Stein postulated, is for the government to deficit spend as if the country were at full employment (4%), what Keynesians today would call “potential” GDP. If the government spends as if the economy were producing at full employment, then the economy would actually reach full employment and the deficit spending could slowly decrease. While no evidence indicats this would work small details have never stopped government economists from experimenting, after all “we must do something.”
    Nixon faced a budget problem when he entered office. Lyndon Johnson’s “Great Society” not only took current tax revenues, it also took future revenues; budgets arrived in congress with a built in deficit. The Great Society passed tax collection to the states in what we today call unfunded mandates. The Great Society would provided 75% funding for a program if the state provided 25%. The states, not wanting to lose federal funding to other states, increased taxes to fund the 25% of the Great Society program.
    By the time Nixon took office the states were crying to Washington to help fund federal social programs so state politicians did not have to continue to raise taxes.
    The climate in 1970 was ripe. Unemployment was climbing and Nixon needed a new way to feed his “New Federalism,” so Stein easily sold his 1947 idea. In January 1971 Nixon proposed a $4 billion revenue sharing scheme telling congress it would be a self-fulfilling prophecy.
    But for the scheme to work Federal Reserve Chairman Arthur Burns had to expand the money supply. In April 1971 the National Observer reported that Burns at the beginning of the year was slow in providing the credit needed, but in April Burns proudly stated the country is “awash in credit.” In the first two quarters of 1971 Burns increased the money supply 11% to stimulate the economy.
    But the harsh world of unintended consequences actually intended consequences since any rational economist should have seen them US interest rates fell from 8% to 3.5% and money that was flowing into the US now flowed back to Europe, and gold flowed out of the US Treasury. The design of the Bretton Woods system made all currencies extensions of the dollar, so dollar inflation spread directly to the rest of the world. At the end of March 1971 the European bankers visited Burns begging him to slow his loosening of credit.
    The US refused to end Steins Keynesian experiment, Burns continued his stimulus, and the Bretton Woods system exploded.
    But wasnt it worth it to reach Nixons goal of full employment? Unemployment at 5.6% in November 1971 moved up to 6% in April 1971 after Burns stimulus.
    Today the Obama administration is repeating the foolishness of Nixon, Stein and Burns, but the difference is credit expansion funds bubbles rather than gold out-flow. Ultimately credit expansion will fund inflation just as Nixons policies created the inflationary 1970s. But more serious to the average person is unemployment. Those whose mantra is unemployment is a lagging indicator become tedious when rates are forecast to continue near Great Depression levels more than two years after stimulus was to have solved the problem.
    Those who dont know history are destined to repeat it. Edmund Burke

  3. IM

    “Ultimately credit expansion will fund inflation just as Nixon’s policies created the inflationary 1970s.”
    In January 2009, the first month of Obama Inflation was at – 0,15%. In the first month of Nixon January 1969 inflation stood at 4,69%: that is a different situation and I don’t think Obama has to worry a lot about inflation right now. One could quibble ewith your history anyway; inflation was a bit lower in Jan 1973 than four years ago. So the history of infaltion in the age of Nixon is not that linear either.
    “But more serious to the average person is unemployment. Those whose mantra is “unemployment is a lagging indicator” become tedious when rates are forecast to continue near Great Depression levels more than two years after stimulus was to have solved the problem.”
    Wait, unemployment is not a lagging indicator?
    The stimulus was supposed to solve the problem in 2010 or so. So two years later would be 2012. Who is forecasting unemployment rates of 20% in 2012?

  4. GNP

    For a long time I have believed that the economics professions overwhelming supported the macro benefits of automatic fiscal stabilizers; however, for the most part the profession was highly sceptical if not outright critical of the purported benefits of discretionary fiscal stimulus. Has that changed? Or is the public discourse simply being drowned by the volume of those who support discrete fiscal stimulation?

  5. Menzie Chinn

    DickF: Thanks for the history lesson. If we’re quoting aphorisms, I guess you haven’t heard of “brevity is the soul of wit.” In any case, I’m not sure from what planet this lesson is from. Here’s a quote from your comment:

    But wasn’t it worth it to reach Nixon’s goal of full employment? Unemployment at 5.6% in November 1971 moved up to 6% in April 1971 after Burns stimulus.

    I assume there’s a typo in there. In any case, you’re blaming revenue sharing for the collapse of Bretton Woods? Some perspective and numbers might be useful to put this assertion into context. 1970Q4 government spending on goods and services as 22.7% of GDP, nondefense was 14.6% (NIPA definitions). By 1972Q1, the figures were 21.8% and 14.4%…

    If you say mid-70′s inflation was due in major part to overexpansionary monetary policy, well that’s more reasonable. But that’s a different point than saying revenue sharing caused the inflation.

    By the way, UE during the Great Depression hit 23%-32% in 1932, depending on labor force definition. Who exactly is forecasting that “…rates are forecast to continue near Great Depression levels more than two years after stimulus was to have solved the problem.”

  6. Mark A. Sadowski

    @GNP,
    Let me answer your question by quoting Krugman’s most recent article:
    “Between 1985 and 2007 a false peace settled over the field of macroeconomics. There hadnt been any real convergence of views between the saltwater and freshwater factions. But these were the years of the Great Moderation an extended period during which inflation was subdued and recessions were relatively mild. Saltwater economists believed that the Federal Reserve had everything under control. Freshwater economists didnt think the Feds actions were actually beneficial, but they were willing to let matters lie.
    But the crisis ended the phony peace. Suddenly the narrow, technocratic policies both sides were willing to accept were no longer sufficient and the need for a broader policy response brought the old conflicts out into the open, fiercer than ever.
    Why werent those narrow, technocratic policies sufficient? The answer, in a word, is zero.
    During a normal recession, the Fed responds by buying Treasury bills short-term government debt from banks. This drives interest rates on government debt down; investors seeking a higher rate of return move into other assets, driving other interest rates down as well; and normally these lower interest rates eventually lead to an economic bounceback. The Fed dealt with the recession that began in 1990 by driving short-term interest rates from 9 percent down to 3 percent. It dealt with the recession that began in 2001 by driving rates from 6.5 percent to 1 percent. And it tried to deal with the current recession by driving rates down from 5.25 percent to zero.
    But zero, it turned out, isnt low enough to end this recession. And the Fed cant push rates below zero, since at near-zero rates investors simply hoard cash rather than lending it out. So by late 2008, with interest rates basically at what macroeconomists call the zero lower bound even as the recession continued to deepen, conventional monetary policy had lost all traction.
    Now what? This is the second time America has been up against the zero lower bound, the previous occasion being the Great Depression. And it was precisely the observation that theres a lower bound to interest rates that led Keynes to advocate higher government spending: when monetary policy is ineffective and the private sector cant be persuaded to spend more, the public sector must take its place in supporting the economy. Fiscal stimulus is the Keynesian answer to the kind of depression-type economic situation were currently in.”
    http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=4&partner=rss&emc=rss&pagewanted=all
    I think it’s safe to say that even the economists who speak most forecefully in favor of the current discretionary fiscal stimulus perceive it as a macroeconomic policy tool of last resort. “Zero lower bound” is one way to describe the current situation that renders it mandatory. “Liquidity trap” is another.
    Under normal circumstances a discretionary fiscal stimulus is not at all necessary and it has several important disadvantages compared to discretionary monetary policy. These include the fact that it requires legislation, it increases the public debt, and that there is usually an implementation time lag.

  7. Mark A. Sadowski

    @DickF,
    Frankly, I found your history lesson somewhat incoherent and rambling. I have my own history of events during 1970-1974 concerning unemployment, inflation and discretionary economic policy:
    1) The State and Local Assistance Act (revenue sharing) wasn’t signed into law until October 1972. It did not add a significant amount to the Federal deficit.
    2) We now know in retrospect that during much of this period NAIRU, the non accelerating inflation rate unemployment rate, was 6.0%-6.2%. Thus even at the worst point of the 1970 recession, unemployment was never actually above NAIRU.
    3) Despite the fact that the economy was already at or above above potential output, and inflation was already moderately high (3%-6%), a loose monetary policy was run from early 1971 through late 1972. This was partly due to Nixon’s desire to get reelected in 1972 (the Federal Reserve was much less independent in those days).
    4) As a result unemployment fell from a peak of 6.1% in August 1971 to a low of 4.6% in October 1973. In addition since unemployment fell below NAIRU during this period, year on year CPI surged from a low of 2.9% in August 1972 to a high of 12.2% in November of 1974.
    In short, there was little in the way of discretionary fiscal stimulus. However there was a good dose of discretionary monetary stimulus that succeeded in lowering the unemployment rate well below NAIRU long enough to get Nixon reelected. However the price that was paid was an accelerating inflation rate.

  8. GregL

    State and local government spending held up because of the timing of their budget cycles. Most budget years start on July 1 or Sept 1. In 2008, the downturn wasn’t bad enough to cause the assumptions in budgeting to change much. The budgets were set before the Sept/Oct meltdown in 2008.
    State and local government pretty much kept to the budgets and in the process ate through their reserves. The budgets starting this year in July and Sept reflect the draconian reality of the mess they are in.
    There is no magic at work here, just some budget timing stupidity.

  9. DickF

    Menzie,
    There are many reasons for the destruction of Bretton Woods but all come back to credit expansion. Some are pointed out by conservative Kenyesians such as the Great Society others are pointed out by liberal Keynesians such as Nixon’s austerity programs. But all conveniently ignore that after the world monetary system was taken off of gold world inflation exploded.
    Unless you have more than a superficial understanding of the Laffer curve you cannot understand how a combination of highly progressive tax systems and inflation can destroy productivity and leading to excess liquidity in the system.
    Because most of our modern economists are fixed into the demand model all analysis is demand analysis whether Austrian ABCT monetarist analysis or New Keynesian “savings glut” analysis.
    No, it was not Nixon’s revenue sharing that caused the destruction of Bretton Woods. It was the government’s response to fund Nixon that was the cause.
    For those who speak of 2010 or some other later date as the day of stimulus salvation you need to remember your recent history. George Bush promised to “save the free market” by violating free market principles. The promise that stimulus would reduce unemployment did not start with Obama but with Bush in the summer of 2008. Now the Obama team is forecasting unemplyment to be near 10% for all of 2010. If our brilliant economic and monetary “experts” can’t reduce Great Depression unemployment rates in two years we are fools for not forcing them out of office.

  10. DickF

    Mark,
    Obviously you did not live through the Nion years. In the time after the Great Depression but before floating fiat currencies unemployment above 4.5% would drive a president out of office and interest rates and inflation rates above 4% were consider outrageous.
    Because you live in this age of inflation fed consumption high rates are accepted as common. We accept economic errors today that would have horrified grandfathers (or for some of you younger students great-grandfathers).

  11. Mark A. Sadowski

    DickF,
    While I may have been young at the time I was nevertheless quite aware of what was going on. More importantly I’m not only quite familiar with economic and political history, I’m also very familiar the history of economic thought.
    Prior to the early 1970s most policy makers thought that 4% or 4.5% unemployment was a reasonable goal. The idea of a target for the unemployment rate largely grew out of hearings during the passage of The Full Employment Act of 1946. A popular book at the time, “Sixty Million Jobs” (1945) by Henry Wallace probably was responsible more than anything else for those specific figures. Well in any case, when Nixon entered office in January of 1969, the unemployment rate was 3.4%. An unemployment rate of 6% probably would have somewhat hindered his reelection chances in November of 1972.
    During the 1960s most Keynesian economists believed in the concept of a fixed relationship between unemployment and inflation, or a Phillips Curve. But this relationship seemed to break down starting in the late 1960s. (The term “stagflation” was coined by British politician Iain Macleod in 1965.) This gave rise to the “accelerationist hypothesis” by Monetarists Milton Friedman and Edmund Phelps, which essentially stated that any attempt to hold the unemployment rate below the “natural rate” would lead to accelerating inflation. They advocated a nonactivist approach to monetary policy believing that the unemployment rate would tend towards the natural rate without any intervention.
    Then in 1975 Franco Modigliani and Lucas Papademos coined the term noninflationary rate of unemployment (NIRU) which was later revised to nonaccelerating rate of unemployment (NAIRU). While Friedman and Phelps believed that the existence of a natural rate implied that there was no useful trade-off between inflation and unemployment, Modigliani and Papademos interpreted the NAIRU as a constraint on the ability of policymakers to exploit a trade-off that remained both available and helpful in the short run. But despite the fundamental differences that still existed between the
    Monetarists and the Keynesians, the NAIRU was seen by many contemporary economists as helping build a consensus about the nature of the inflation-unemployment relationship.
    At first there was an attempt to estimate a fixed NAIRU for the United States that was valid for all time periods (usually estimated to be between 5.5% and 6.0%). By the late 1990s, as unemployment dropped well below that rate and yet inflation continued to be moderate, this idea was questioned. Now it is fairly well accepted that NAIRU varies over time. The CBO maintains a NAIRU data series that ranges from a high of 6.2% in the mid 1970s to a low of 4.8% since 2001.
    Now, on the subject of fiat currency, most Monetarists and Keynesians view floating exchange rates as a vast improvement over fixed exchange rates. This is primarily because it frees the central bank from worrying about defending the exchange rate, so that it can instead focus on targeting inflation and unemployment. Certainly the early period following the abandonment of Bretton Woods, particularily 1973-1983, was marred by great instability in inflation, interest rates and unemployment, but the period immediately preceding its demise was not exactly a model of economic stability either.
    And if one goes further back, what you will observe is the following. During the period 1857-1913, the United States spent fully half of its time in recession, and recessions lasted on average 22.5 months. The recession following the Panic of 1873 alone lasted 65 months (that’s just the contraction). It was estimated by Stanley Lebergott that the unemployment rate following the Panic of 1893 peaked at well over 14% and stayed in the double digit range for six years. And between 1776 and 1913 there were five extended periods of double digit inflation in the United States as well as six extended periods of double digit deflation. There were several episodes of double digit short term interest rates as well. Much of this dramatic and persistent roller coaster of economic instability is directly attributable to a fixed exchange rate regime. That’s because our monetary policy was literally hostage to the wax and waning of the international gold supply. The economy didn’t start to recover from the Panic of 1893 for example until after the start of large scale gold mining in South Africa in 1896.
    The current judgment of economic historians (see, for example, Barry J. Eichengreen, Golden Fetters) is that attachment to the gold standard played a major part in keeping governments from fighting the Great Depression, and was a major factor turning the recession of 1929-1931 into the Great Depression of 1931-1941. Commitment to the gold standard prevented Federal Reserve action to expand the money supply in 1930 and 1931, and forced President Hoover into destructive attempts at budget-balancing in order to avoid a gold standard-generated run on the dollar. The standard interpretation of the Depression, dating back to Milton Friedman and Anna Schwartz’s Monetary History of the United States, is that the Federal Reserve could have but for some mysterious reason did not boost the money supply to cure the Depression. Friedman and Schwartz do not stress the role played by the gold standard in tieing the Federal Reserve’s hands, the “golden fetters” of Eichengreen.
    But Friedman was keenly aware of the role played by the gold standard, hence his long time advocacy of floating exchange rates, the antithesis of the gold standard.
    In the entire period since the abandonment of fixed exchange rates through 2007 on the other hand you will observe the following. We were in recession less than 13% of the time and recessions lasted an average of only 10.8 months. We did have two periods of double digit inflation and high interest rates, but on an annual basis the unemployment rate never exceeded 9.6%. And during the fourteen years from 1994-2007, core PCE inflation stayed with in a narrow range of 1.4% to 2.3% on an annual basis, the federal funds rate never exceeded 6.5%, and the unemployment rate never exceeded 6.3%. This phenomenon is part of what what gave rise to the coining of the term the Great Moderation by Harvard economist James Stock in 2002.
    Neither our grandfathers, our great-grandfathers, nor even our great grandfathers ever experienced such a prolonged period of economic stability. Unfortunately we are entering a period of time where unemployment is likely to be quite high (even double digit). But I hardly think flexible exchange rates are to blame, or that fixed exchange rates could have prevented it.

  12. Brian D. Quinn

    DickF wrote: “In the time after the Great Depression but before floating fiat currencies unemployment above 4.5% would drive a president out of office and interest rates and inflation rates above 4% were consider outrageous.”
    Considering between the election of FDR and Richard Nixon no incumbent president was defeated this is an interesting historical statement. It was never proven whether people would have tolerated higher unemployment rates. However, as a point of fact, unemployment was higher than 4.5% at 4.8% in November of 1964 and Johnson won quite nicely.
    If you go by party changes instead, we changed parties in 1952, 1960, and 1968. Unemployment rates were 2.8%, 6.1%, and 3.4% respectively. Party changes since then have happened at 7.5%, 7.4%, 3.9%, and 6.8%. There really isn’t much of a correlation at all. Additionally, that is a very limited set of observations.
    To return to the larger point, you are inconsistent with regard to your economic philosophy with the exception of your belief in the gold standard. You invoke the post-WWII through 1972 era as one of low unemployment and inflation as a positive economic model, but decry heavy government intervention in the economy. The government was larger as a share of GDP in the 1946-1970 period on average than it has been since 1980. Regulations were far more stringent. Government stimulus programs in the form of infrastructure projects, such as the interstate highway system, were routine. Up until this financial crisis, nothing in the post-Reagan period comes close to rivaling the government’s role in the economy than the first two decades after WWII.
    FYI, to state that there was no price instability in that period is folly: http://research.stlouisfed.org/fred2/graph/?chart_type=line&s1id=CPIAUCNS&s1transformation=pc1
    You seem to be invoking a small period of time, in the late 1950s, which was punctuated by two recessions, and the 1960s, which saw an accelerating inflation rate throughout the decade until by 1969 it was reaching nearly 5%. To look at a small solitary period in economic history and generalize it as you do is profoundly intellectually dishonest. Inflation was, on average, lower in the 1950s and 1960s, but compared to the 1990s, not meaningfully so.

  13. Jim Glass

    This post, while focusing exclusively on the level and trend of state government employment, oddly omits Mulligan’s fundamental point:
    “by the time the stimulus law was being debated this January, the private sector had lost four million jobs during this recession, whereas state and local government employment had grown by 124,000.”
    It plainly misrepesents Mulligan’s position to say: “Mulligan asserts that aid to the states and localities is unwarranted given that state and local government employment is doing just fine.”
    Mulligan’s enire argument is that compared to private sector employment the loss of public sector employment has been quite small…
    “In the average month, over two million private-sector employees were let go, as compared to 96,000 state and local government employees.”
    That’s a 20-1 ratio — and yet …
    “one-third of the aid in the ‘stimulus’ law is aimed at state and local governments. This allocation … vastly overstates the importance of state and local government in the national employment picture, and thereby diminishes the laws potency as a stimulus to national employment.”
    THAT’s Mulligan’s argument in his own words — and clearly it isn’t conveyed at all (much less fairly so) without including the numeric comparison between the two sectors. One wonders why it was omitted in a purported answer to what he wrote.
    Mulligan closes…
    “Economic analysis does not support the extraordinary importance afforded state and local governments by the stimulus law” … compared to the importance of private sector employment and economic activity.
    Well … is he wrong?
    Is there a contrary opinion that economic analysis does support the idea that state government employment and activity is so much more important than private sector employment and activity, as to be deserving of such disprortionate stimulus support?
    (The private sector produces plenty of positive externalities too, we all know. And public goods as well.)
    “… but political analysis might. In particular, patronage jobs are an important part of the political participation machine. Perhaps when members of Congress were talking about ‘saving jobs’ as they authored the stimulus law, they were talking about 535 specific jobs their own!”
    There’s plenty of economic analysis of the public choice theory sort supporting that propostion.
    (We also have supporting evidence, such as the politicians in New York diverting $350 million of stimulus money purportedly for transit construction instead into an 11% raise for current Transit Worker Union employees, as I mentioned previously.)
    Mulligan raises a fair question. If there is an economic justification for state government receviving disporportionately far more stimulus than the private sector, relative to job losses, total employment et al. (and it’s not the public choice reason), what is it?

  14. Menzie Chinn

    Jim Glass: I’m sure the private sector produces all sorts of externalities, both positive and negative. But in the absence of intervention, the private sector underprovides those goods with positive externalities. At least that’s what a introductory micro text would say.

    If we take the optimizing framework that is implicit in Mulligan’s worldview, then the private sector employment and output (aside from distortionary taxes, subsidies) is at optimal levels. Hence, if Mulligan were to be internally consistent in his arguments, his point on relative job losses would be irrelevant.

  15. DickF

    Mark,
    Your post is outstanding!!!
    Where you are I part ways is that you accept the common myth of the Great Depression and especially Eichengreen’s gold hypothesis. Eichengreen has an extremely strong vested interest in maintaining his gold myth since it is his lifes work.
    While Nixons closing of the gold window is usually accepted as the time the US broke with a gold standard it actually occurred when the Federal Reserve was created. Through the 1920s Benjamin Strong manipulated the money supply from the New York FED to curb the gold flows coming from the UK to the US so we were at best on a psudeo-gold standard. This was a period of artificially low interest rates to prop up the pound sterling (a futile effort as events proved).
    What Milton Friedman identified as deflation at the beginning of the Great Depression was actually a contraction similar to what we experienced in 2008 after Paulson’s “stilmulus.” Demand crashed because production crashed, the terms of trade were virtually destroyed with Smoot-Hawley and international retaliation, Hoover’s artificial wages and prices and his massive public deficit spending, not to metion tax foolishness. Had the Federal Reserve not contracted the money supply in the early 1930s we would have had massive stagflation and Friedman would have never had a monetarist theory to write about.
    Today all demand model analysts, whether liberal Keynesians, conservative Keynesians (monetarists) or modern Austrian monetarists over-estimate the power of money. Money is simply a medium of exchange and whether its supply increases or decreases has little effect on the actual terms of trade. The reason inflation had such a destructive effect during the 1970s was because of the draconian progressive tax system throughout the whole world. Each episode of inflation drove the average person higher and higher up the Laffer curve and eroded purchasing power. Someone making $5,000 per year in 1970 had to make $50,000 per year in 1980 just to stay even, but the taxes on $5,000 were minimal compared to taxes on $50,000. Wages that just stayed even with inflation lost a huge amount of purchasing power because of the progressive tax code.
    Today we are repeating the same errors as the past. There were credit expansion errors before the Crisis of 1819 by the state banks. In the 1830s there was renewed inflation by the state banks when the 2nd BoUS was closed and Andrew Jackson created sudden massive deflation leading to the Crisis of 1837. Abraham Lincoln created a similar credit crisis when he issued the Greenbacks during the Civil War and Lincolns error caused problems all the way through the latter 19th Century just as Nixon caused the problems of the latter 20th Century. There have been very limited periods in the history of our nation when there was not an economic crisis caused by government intervention usually meaning credit expansion in a foolish attempt to create growth.
    Finally, I know that the myth of economic stability says that things were worse before the Federal Reserve and floating currencies but it is just that, a myth. The 20th Century was one of the worst economic periods in world history. The 1907 crash was followed by the huge economic contraction of 1920-21. Then the Great Depression that devastated people throughout the entire world led us into the Great Inflation that brought chronic inflation to industrialized nations and hyper-inflation to the Third World. Had it not been for Ronald Reagan and in a strange way Greenspan returning to a psuedo-gold standard, the latter half of the 20th Century would have been a greater turmoil than any century before.
    Right now we are entering another serious economic period and I see the US government making the same mistakes it has for centuries, since the issuance of the Continental to fund the Revolutionary War. We have had few Alexander Hamiltons, or Ronald Reagans to pull us back from the abyss. Hopefully there is another nearby to correct our current foolishness.

  16. Buzzcut

    Some other interesting and related tidbits:
    1) the share of jobs held by the… fairer sex ;) is the highest it has ever been at 49.9%. This is not surprising when you think about how many teachers and public employees are female.
    2) wages for federal employees are now twice that of private sector workers.
    3) public employees are now 50% unionized, far outstripping private sector unionization, which is still in decline. Unions have largely become a public sector phenomenon, pitting taxpayers against unions.
    It would be a healthy thing for public sector employment to fall more during a recession than private sector employment. There needs to be a clearing of the dead wood in the public sector just as much as in the private sector. If not during a recession, when?
    Okay, that’s not countercyclical, nor something for macroeconomists to ponder.

  17. Mark A. Sadowski

    @DickF,
    Well, I’m both elated and very surprised that you actually enjoyed my last comment. And perhaps I can somewhat return the compliment by saying your last post seems to display a different side of you than I remember reading. While I profoundly disagree with your interpretation of the facts, at least I don’t see any facts that I disagree with.
    Just a few comments:
    I agree that it’s important to separate the period since the founding of the Federal Reserve from the rest of the period prior to floating exchange rates. Economic behavior did change, and aside from the Great Depression, it changed mostly for the better. (For example, average growth in real GDP per capita increased from 1.5% from 1790-1913 to 2.1% from 1913-2008.)
    Certainly there were supply side economic policies under Hoover and FDR that aggravated the Great Depression but I still think the evidence strongly supports a demand side interpretation of events. In particular I find Lee Ohanian’s strained efforts at using labor market behavior during that period to explain the Great Depression to be not very credible. And even if there had not been a deflationary Great Depression, Friedman probably would be remembered for “A Monetary History of the United States” and his very timely accelerationist hypothesis in the late 1960s.
    You would probably label me a “liberal Keynesian” (I’m somewhat comfortable with that) and I find it gratifying that you don’t see much difference between Keynesians and Monetarists. Fundamentally they’re two sides of the same coin (pun intended). They only differ on the question of the potential existence of long term disequilibriums and the consequent necessary fiscal policy response. All modern Keynesians (Neo-Keynesians) are really Monetarists until a liquidity trap appears. And I find RBC/Neo-Classicists to be delusional in their belief that all recessions can be explained by supply shocks, and that the unemployed are “merely displaying a preference for leisure.” I think the global financial crisis has really put them on the defensive. (I even heard a rumor that Robert Lucas was quoted recently as saying “all economists are Keynesians when in a foxhole,” so maybe he’s finally seen the light, but I’m not holding my breath.) And as for the Austrians, I find them to be very peculiar in their medievalian contempt for inductive reasoning and their masochistic faith in “hangover theory” and “creative destruction.” (I imagine that they’re self-flagellating in some damp dark cold dungeon somewhere when they’re not commenting incoherently on econ blogs.) Since you seemingly deride them (and I take it you’re probably not a RBC/Neo-Classicist), but yet you are a fan of the Laffer Curve and the gold standard, I’m not sure how to classify you. (Perhaps you should found your own school of economic thought.)
    I’m highly critical of the Laffer Curve. The empirical evidence for it is simply not there. In terms of the labor market there is actually a fair amount of evidence that the labor supply curve bends backwards above a certain level so that the total wage elasticity of labor supply is actually negative. Thus reductions in the top marginal tax rate actually have the seemingly perverse effect of inducing people to work less, not more. (Everybody has only 24 hours in a day, and those with high rates of income value their scarce time over an additional flood of money.) And even those studies that claim to estimate the Laffer Curve put the revenue maximizing rate in the 65%-85% range, far higher than most supporters would apparently like. I’m more amenable to its possible existence with respect to corporate taxes but again the evidence is very weak. In any case it might surprise you to learn I’m in favor of the elimination of the corporate tax (although not the elimination of dividend taxation or inflation indexed capital gains taxation). That’s because supply of capital is highly elastic, unlike labor. My own humble research indicates that low corporate tax rates strongly contributed to the boom experienced in Ireland and the Baltic States in the late 1990s and early 2000s, but primarily because foreign direct investment brought advanced production technology to those underdeveloped nations that nevertheless already had abundant human capital and good physical infrastructure.
    I view the history of US macroeconomic policy as evolutionary. Each crisis causes us to refine it somewhat. The Panic of 1907 led to the creation of the Federal Reserve. The Great Depression led to an acknowledgement of the government’s duty to ameliorate recessions. The balance of payments crisis led to the adoption of a flexible exchange rate. And that, coupled with the rise of stagflation, led to a much more coherent monetary policy.
    The current crisis will hopefully lead to a greater acknowledgment of the importance of the flow of funds and asset prices. In fact I heard that the OECD is modifying its macroeconomic forecasting model to reflect asset prices (something that was long overdue). And in my opinion the current crisis is the product of both too much government intervention and too little (what we need is Goldilocks, not extremism).
    There was too much government intervention in the form of tax policy. I don’t think it’s too surprising that the housing bubble started to inflate almost to the day that the Taxpayer Relief Act was passed in 1997. It led to greatly expanded real estate capital gains exclusions and granted tax expenditures (capital gains exclusions and mortgage interest and property tax deductions) to second homes for the first time in our nation’s history.
    There was too little government intervention in the form of too liberal standards for regulation. In particular the Garn-St. Germain Depository Institutions Act of 1982 legalized the insidiously evil adjustable rate mortgage. That, coupled with lax standards on down payments, helped fuel the speculative real estate frenzy once the tidal wave of tax expenditures was released in 1997. (We need to go back to “plain vanilla” 30 year fixed rate mortgages with 20% down payments. Very boring but incredibly safe.) In addition the Commodities Modernization Act of 2000 led to the creation of the unregulated over the counter derivatives market which only added high octane financial fuel to the already raging fire.
    In any case, that’s how I view our current situation. I see our economic history as evolutionary. If I may say so, you seem to see our economic history as devolutionary.

  18. jturner

    I agree that the current problems were not most likely not caused by floating exchange rates. I feel they were caused by the Fed keeping rates at all time lows and encouraging a huge buildup in debt. And now they are trying to recreate the debt bubble that burst. They are even willing to potentially sacrifice the dollar in the process, which I find very reckless.

  19. DickF

    Mark,
    Thank you for spending the time to give me such a thoughtful reply. I apologize for this being so long but I still left out a lot of comments. There was much to say.
    You wrote:
    the period since the founding of the Federal Reserve the period prior to floating exchange rates. Economic behavior did change it changed mostly for the better. (For example, average growth in real GDP per capita increased from 1.5% from 1790-1913 to 2.1% from 1913-2008.)
    This is an impossible correlation because the 10 fold inflation of the 1970s distorts any such measure of GDP. It is also confused by the Cantillon effect because not all prices uniformly increased 10 fold.
    even if there had not been a deflationary Great Depression, Friedman would be remembered for “A Monetary History of the United States” and his very timely accelerationist hypothesis in the late 1960s.
    Had the FED allowed inflation during the Great Depression as Friedman suggested he would have had to totally change his Monetary History conclusions. Monetarism as we know it today would not exist because the monetary illusion would have been totally exposed.
    You would probably label me a “liberal Keynesian”
    I find labels difficult for my economics. I am a supply side economist, but the term has become so bastardized by men like Larry Kudlow and Bruce Bartlett and then by an ignorant media it is unrecognizable. I draw supply side foundationally from Robert Mundell and Jude Wanniski and with todays economists I am closest to John Tamny.
    and that the unemployed are “merely displaying a preference for leisure.”
    The unemployed are doing what they believe is best for them. To illustrate I have a friend who worked as a commercial loan underwriter for Citi who was laid off. She ended up losing her home and is virtually destitute now. She desperately wants to work. This weekend she said that soon she will just have to get a job as a cashier or something because her unemployment will run out. What that demonstrates is not that the unemployed prefer leisure, but that the government is paying people to be unemployed. My friend would be working now if she did not have unemployment payments. Such a job would not be as good as she had in the past, but she would be contributing to production rather than drawing from it through tax funded unemployment payments. I have heard it said that a society can have just as much unemployment as it is willing to pay for.
    Austrians, I find them to be very peculiar in their medievalian contempt for inductive reasoning and their masochistic faith in “hangover theory” and “creative destruction.” Since you seemingly deride them (and I take it you’re probably not a RBC/Neo-Classicist),
    Dont misunderstand my comments on Austrians. I am closer to Austrians than to any of the demand models. My break with Austrians is with the modern Austrians who follow monetarist reasoning in their ABCT. I believe Mises and Hayek are two of the greatest economists to ever live.
    you are a fan of the Laffer Curve and the gold standard, I’m not sure how to classify you.
    I would label myself a supply side economist but that is difficult because men like Larry Kudlow have so bastardized the discipline not to mention the ignorant rants of the media. Foundationally, I follow Robert Mundell and Jude Wanniski and am closest to John Tamny of todays economists.
    I’m highly critical of the Laffer Curve. In terms of the labor market there is actually a fair amount of evidence that the labor supply curve bends backwards above a certain level so that the total wage elasticity of labor supply is actually negative. Thus reductions in the top marginal tax rate actually have the seemingly perverse effect of inducing people to work less, not more. (Everybody has only 24 hours in a day, and those with high rates of income value their scarce time over an additional flood of money.)
    This is a typical misunderstanding of the Laffer curve. In society there is a money economy that can be seen and taxed by the government and a non-money economy that cannot be seen or taxed by government. The loss of revenue due to prohibitive taxes is not because they induce people to work less but that it pushes them out of the money economy. Obvious examples are the black market, the barter economy, and tax exempt investments (these are clear examples because if the tax exemption is removed investors disappear).
    You also demonstrate another misunderstanding of the Laffer curve. Point E on the Laffer curve is the optimal point of tax revenue at a given tax rate. Any change in the rate above or below point E will lower total tax revenue. E is not a fixed point but changes depending on circumstances, for example during a war taxpayers have a greater tolerance for taxation and point E can be extremely high. The misunderstanding is the assumption that the Laffer curve claims a fixed rate and that lower tax rates will always raise tax revenue. If E changes even the same tax rate can lower tax revenue (again to use war, going from war to peace obviously changes the location of E on the curve).
    I don’t think it’s too surprising that the housing bubble started to inflate almost to the day that the Taxpayer Relief Act was passed in 1997. It led to greatly expanded real estate capital gains exclusions and granted tax expenditures (capital gains exclusions and mortgage interest and property tax deductions) to second homes for the first time in our nation’s history.
    Prosperity leading to an increase in home purchases is a good thing while a credit induced bubble is not. But you cannot distinguish the two by only looking at numbers. A reductions in the wedges (removal of real estate capital gains taxes, lower market interest rates, general property tax reductions, etc) resulting in greater home ownership is a good thing and is self-sustaining. Government subsidy of real estate through incentives funded by expansion of the money supply is a bad thing and is unsustainable as our current crisis has proven.

  20. Mark A. Sadowski

    @DickF,
    You wrote:
    “This is an impossible correlation because the 10 fold inflation of the 1970s distorts any such measure of GDP. It is also confused by the Cantillon effect because not all prices uniformly increased 10 fold.”
    Rubbish. Any price index that doesn’t take into account changing spanding habbits is pure bunk.
    “I find labels difficult for my economics. I am a supply side economist, but the term has become so bastardized by men like Larry Kudlow and Bruce Bartlett and then by an ignorant media it is unrecognizable. I draw supply side foundationally from Robert Mundell and Jude Wanniski and with todays economists I am closest to John Tamny.”
    Bartlett and Mundell are good. Kudlow and Tamny not so much.
    “This is a typical misunderstanding of the Laffer curve. In society there is a money economy that can be seen and taxed by the government and a non-money economy that cannot be seen or taxed by government. The loss of revenue due to prohibitive taxes is not because they induce people to work less but that it pushes them out of the money economy. Obvious examples are the black market, the barter economy, and tax exempt investments (these are clear examples because if the tax exemption is removed investors disappear).”
    Then the Laffer Curve would be percieved by econometric analysis. But it is not. There has never ever been a Laffer Curve detectable by our given senses. It is simply faith and not reason. And without an estimatable Laffer Curve how can you even argue in such a thing as point “E.”
    “Prosperity leading to an increase in home purchases is a good thing while a credit induced bubble is not. But you cannot distinguish the two by only looking at numbers. A reductions in the wedges (removal of real estate capital gains taxes, lower market interest rates, general property tax reductions, etc) resulting in greater home ownership is a good thing and is self-sustaining. Government subsidy of real estate through incentives funded by expansion of the money supply is a bad thing and is unsustainable as our current crisis has proven.”
    What you describe as reductions in wedges are actually increases in wedges. When you create a tax preferance for a specific asset or expenditure you provide it with a subsidy that makes it preferable to any kind of asset or expenditure not so blessed.

  21. DickF

    Mark,
    I have to question your logic on two points.
    Point 1
    …the Laffer Curve would be percieved by econometric analysis. But it is not. There has never ever been a Laffer Curve detectable by our given senses.
    The Laffer curve is as old as civilization. The Laffer curve has entered the writings of all men who understood the law of diminishing returns as it applies to tax policy. It was understood by Ibn Khaldun, Caesar Augustus, Montesquieu, Napoleon, David Hume, Adam Smith, Ludwig Erhard, and Andrew Mellon all before Art Laffer drew the curve on a napkin.
    You also err by assuming economic principles are only valid if they can be expressed in econometric terms. Rhetorically, almost all economists recognize that economics is a behavioral science, but today many have rejected behavior for graphs and equations.
    Point 2
    What you describe as reductions in wedges are actually increases in wedges. When you create a tax preferance for a specific asset or expenditure you provide it with a subsidy that makes it preferable to any kind of asset or expenditure not so blessed.
    The logic in this statement is that if I steal from you then return enough for you to have cab fare home I have provided you with a subsidy and created a wedge. Wrong! The wedge was created with the theft not with the return of original property.
    This is a modern political, rhetorical trick to call any reduction in confiscation a “gift.” For example when congress initiates a budget any reduction in the increase over the prior year is called a “cut.” So if the budget is increased 10 fold then reduced to only a 9 fold increase congress calls this a cut. Your logic is the same.

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