CBO on the Stimulus Package, and Still No Expansionary Fiscal Contraction in UK

Two Items Regarding Fiscal Policy


US GDP and the Stimulus Package


The 2nd release for US GDP revealed a downward revision BEA; CR reports the breakdown. What is interesting is that the downward revision is due in part to a greater than previously estimated decline in the state and local government spending contribution. Something useful to keep in mind as state and local governments move to rely solely upon spending cuts instead of revenue increases as means to reduce budget deficits (e.g., as in Wisconsin).


A couple days ago, CBO released its most recent evaluation of the impact of the American Recovery and Reinvestment Act (ARRA). Using Table 1, I obtain the following implied values for GDP in the absence of the stimulus, assuming low and high values for multipliers.


gdpfeb1.gif

Figure 1: GDP, SAAR in bn Ch.2005$ (black), mean forecast from Survey of Professional Forecasters (blue), and counterfactual using low multipliers (salmon) and using high multipliers (teal). NBER defined recessions shaded gray. Source: BEA, 2nd release for 2010Q4 GDP; February Philadelphia Fed Survey of Professional Forecasters, and CBO, Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from October 2010 Through December 2010, Table 1, and author’s calculations.

Even with conservative values for the multipliers, the estimates imply that in the absence of the stimulus package, output would still be about $145 billion Ch.2005$ lower than the 2008 peak; under the high range values, approximately $450 billion.


Going forward, lots of discussion in the blogosphere about oil, ouptput and inflation. For a nuanced view of what the impact of higher oil prices will be, see Jim Hamilton and Macro Advisers. Also Leblanc and Chinn.


Update on Expansionary Fiscal Contraction


Crossing the Atlantic, one finds that the (short term) evidence in favor of an incipient expansionary fiscal contraction (see here for previous post) is getting weaker and weaker, even for an open economy like the UK. The 2010Q4 estimate for UK GDP was revised down from -0.5% (q/q) to -0.6% (essentially -2.6% on an annualized basis). Hence, the possibility that the negative reading was due to mis-estimation of the impact of bad weather has been largely ruled out, since the estimated impact has been held at negative 0.5 ppts.


If one is hoping that at least firms are anticipating positive effects from the coming spending cuts, the behavior of gross fixed capital formation (investment) is not promising. In 2010Q4, this series was declining 2.5% q/q (-9.7% on an annualized basis), contributing -0.4 ppts of the overall 0.6 ppts q/q decline in GDP.


gdpfeb2.gif

Figure 2: From Office for National Statistics, “UK output, income and expenditure 4th quarter 2010,” (Feb. 25, 2011).

In a commendably understated assessment,

“[e]conomist James Knightley at ING said the declining GDP was “fairly worrying given we know about the wave of fiscal austerity that is now starting to hit the U.K. economy. We will soon be starting to see negative figures for this component.”

Apparently financial sector economists are not expecting a expansionary fiscal contraction either.

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53 thoughts on “CBO on the Stimulus Package, and Still No Expansionary Fiscal Contraction in UK

  1. Mark A. Sadowski

    A few observations about the UK:
    1) Fiscal contraction would do no harm as long as there was monetary expansion.
    2) There will not be a monetary expansion as long as inflation is so high.
    3) Year on year HICP was 3.2% in December. Year on year core HICP was 2.5% in December.
    4) The UK has had two hikes in the VAT in the last 14 months: from 15 to 17.5% in January 2010 and then up to 20% in January 2011.
    5) Adjusting for the influence of the VAT hike yoy HICP was 1.5% in December. Subtracting the influence of food and energy this falls to 0.8%.
    6) Inflation is high primarily because of fiscal contraction (the VAT increase).
    So in short fiscal contraction could be offset by monetary expansion except that the BOE is targeting an inflation rate artificially raised by fiscal contraction.
    And so the beat goes on.

  2. Ed Hanson

    Menzie made the comment;
    “Something useful to keep in mind as state and local governments move to rely solely upon spending cuts instead of revenue increases as means to reduce budget deficits (e.g., as in Wisconsin).”
    And exactly how does a state which can not print money, nor by law have an unbalanced budget, increase its spending?
    I suspect Menzie would say to raise tax rates, or sell bonds, taking the an amount of private capital, and putting the same into the government capital. Then after inefficient bureacrats take their cuts, some magical multiplier will take affect to the benefit of everyone. And if the multiplier again does not appear, then just wait for the Federal government to go further into debt, print more money, and bail out the states.
    Menzie, here is my advise, let the election winners do as they can, and see which state, Illinois across the border (which seems to accept your advice) or your Wisconsin improves the best. My guess, if Wisconsin adds substantial tax rates cuts, to person and business to their spending cuts, Wisconsin will pull easily away.

  3. 2slugbaits

    A challenge for those who disapproved of ARRA: Are you recommending that the US adopt something like the Cameron plan? And where do you think GDP would be today if the GOP had controlled the House in 2009? And for those brave enough to answer the challenge, please provide a coherent model; i.e., go beyond Glenn Beck’s chalkboard explanations.

  4. jonathan

    While I like Mark Sadowski’s comment, I’m not sure we can so easily blame VAT for the inflation.
    But there is another causal chain worth considering: some of the inflation is caused by the relative fall of the pound to the euro, but that fall was in the aftermath of the crisis itself – so UK inflation has remained stubbornly high. VAT may have given the rate a goose but think of this: if you’re relying on exports to finance your growth – and exports were the positive contribution in last GDP report – then it doesn’t help that you already had your devaluation and that further devaluation risks sparking materially higher inflation which then spurs interest rate increases which …

  5. Get Rid of the Fed

    For Ed Hanson and 2slugbaits, it seems to me what you are describing is that there is a shortage of the medium of exchange.

    2slugbaits, I believe there was/were mistake(s) in the past. There was an aggregate supply shock that was not handled correctly. It LATER showed up as what appeared to be an aggregate demand shock.

  6. Nemesis

    Leave out demographics and the declining net energy to private GDP per capita, and one misses the larger global structural effects that are now bearing down on us as a result of Peak Oil and population overshoot.
    Conventional economists do not have the tools or intellectual conditioning (and don’t get paid) to recognize the underlying causal factors associated with the onset of the post-Oil Age epoch, especially Keynesians who emphasis aggregate consumption, regardless of the source and differential rate of growth between the public and private sectors. Keynesians see the solution to everything to be more gov’t spending and/or more debt-money.
    With US oil production per capita now down 60% from the ’70 peak (declining more than 50% after ’01, not coincidentally), we had to create a net 7%/yr. per capita increase in private debt/GDP to achieve a long-term 3.3% real GDP to make up for the loss of domestic oil production and value-add goods production and returns to labor’s share of GDP.
    However, since ’00-’01, real private GDP per capita has contracted to date, and is down even more since ’07, not coincidentally with US oil production decline per capita exceeding 50% and global peak oil production since ’05-’08.
    IOW, we can no longer grow global oil production, debt-money at 6-7% nominal to get 3% real GDP, 6% gov’t spending growth, AND import 50% or more of oil consumption. If we can’t grow private debt, oil imports, and gov’t spending, the auto-, oil-, and debt-based Oil Age growth epoch is over, including for China-Asia. Per capita growth is no longer possible.
    And the US is now on course for per capital oil consumption to decline 70% by no later than ’21-’22 (assuming no further deceleration of US or global depletion), which puts us squarely on target for economic collapse (exceeding the logarithmic point-of-no-return along the oil depletion curve). We will be forced to adapt to using 70% per capita less oil thereafter (and 70%+ decline in debt/asset values), even as China-Asia tries to grow consumption and GDP 8-10% while facing a similar post-Oil Age per capita consumption and GDP collapse, perhaps sooner than the US.
    Note also that Egypt’s per capita oil production is collapsing, which, along with population overshoot, is the primary cause of the collapse of the gov’t.
    Finally, Mexico’s per capita rate of decline of oil production since ’03-’04 is occurring at twice the rate of Egypt’s decline (6-7 years vs. 14 years), and Mexico’s oil exports per capita are collapsing, implying that Mexico will become a net oil importer by no later than ’16-’20. Of course, Mexico won’t be importing oil, as Peak Oil and peak and falling exports from other oil-producing countries with China-Asia demand at 8-10% will not permit Mexico to import oil.
    Consider what effects Mexico’s oil production decline are likely to have on per capita GDP and gov’t tax revenues, and on illegal Mexican immigration to the US.
    There are no Keynesian (or supply-side, Austrian, etc.) solutions to the global structural effects of resource constraints now occurring at the onset of the post-Oil Age epoch. All we can do is adapt as quickly as possible to dramatically less liquid fossil fuel consumption and hope we avoid collapse and mass die-off.

  7. Mark A. Sadowski

    jonathan,
    With all due respect this is not a matter of speculation. These numbers are all easily looked up at Eurostat. Factor out the VAT increase and yoy HICP is just 1.5% even including rapidly increasing food and energy prices. Inflation is not stubbornly high in the UK.
    With respect to your speculation concerning the effect of devaluation it is worth noting that yoy headline HICP rose from 2.6% in July 2008 to 3.8% in March 2009 (the period of devaluation). By late 2009 it had fallen to 2.2%. The subsequent increase to 3.2% took place after the first VAT increase.
    The devaluation did not spur a permanent increase in the rate of inflation and neither will the VAT increases. They are one time effects that are not being reflected in the underlying rate of inflation, which now borders on actual deflation.

  8. tanstaafl

    @nemesis,
    I agree that peak oil will be quite a challenge to the U.S., where no one seems to care about anything beyond the next earnings report or election cycle.
    But there are some good short term alternatives to oil (if you don’t mine the carbon emissions), including coal and natural gas, and oil production in the U.S. might even blip up for a few years as the fracing technique used so successfully in natural gas extraction is applied to oil. Beyond that, if oil gets to $250-300/bbl or so, I would guess that the reluctance to use nuclear power will go away, and there are also biofuels and the shale oil in the western U.S. that will probably become viable at such prices.
    Tough times coming for sure, but no dieoff.

  9. Ed Hanson

    Slugs
    The “Cameron plan” Is a British attempt to solve a British problem of their own making. Unfortunately for them, not being a republic they can only test a solution one at a time. Here in the US we have the capability to test up to 50 plans. That was the challenge I made to Menzie, let the election winners in Wisconsin develop their plan through the legislature process, without Senators shirking the job they were elected to do, and without the President interfering with his own political operatives. A nice geographic test between the direction of Wisconsin compared to Illinois can only promote further enlightenment.

  10. Ed Hanson

    Slugs
    You want a coherent plan? Not all that difficult. Just observe the recovery of the steep recessions of the early 20’s and the early 80’s. Deep and permanent reduction of marginal income tax rates were used in both instances and successfully brought a quick end to high unemployment with sustained high GDP growth. Need I remind you that ARRA has done neither.
    As problems in each age have similarities, they also have their differences. So besides reducing individual income tax rates to the Reagan rate of 25%, the worse tax rate, the corporate income tax rate of 35% has to come down. Our competitors in the world have already discovered.

  11. Ed Hanson

    Get Rid of the Fed
    I certainly do not think there is a shortage of a medium of exchange, only an over supply of those who wish to spend other peoples money.

  12. Get Rid of the Fed

    Ed Hanson, if it wasn’t for the demand deposits created from gov’t debt, was there going to be a shortage of the medium of exchange?

    Even if there isn’t a shortage of the medium of exchange in the recent past/present, could there be a shortage in the future because the composition is wrong?

  13. 2slugbaits

    Ed Hanson Here in the US we have the capability to test up to 50 plans. That was the challenge I made to Menzie, let the election winners in Wisconsin develop their plan through the legislature process,
    First, the decisions of one state are not confined to that state alone. One of the lessons learned from the housing bust is that many states in the midwest that were not part of the housing boom nevertheless suffered some of the biggest losses in the Great Recession. Sometimes recessions reward the guilty and punish the innocent. What happens in Wisconsin doesn’t have to stay in Wisconsin.
    Second, we already have a case study of what happens when the national government follows a policy like that of Britain or Wisconsin. It’s called 1937. Been there, done that, don’t need to relearn old lessons.
    Third, learning from experience is a great thing, but we also have these things called minds that allow us to reason through problems using models. We already have a coherent model that gives us the answer. That model says we need monetary and fiscal policy to stimulate weak aggregate demand. Monetary policy is toothless right now, so that leaves the heavy lifting to fiscal policy. We know what happens when a country cuts back on spending and raises taxes during a recession. We can reason our way through the likely outcome of raising interest rates when core inflation is near zero. This isn’t rocket science…well, okay, I guess they use phase diagrams in rocket science so maybe some of it is like missilery
    http://www.youtube.com/watch?v=g53gFvPT5Lg
    Finally, to return to the Wisconsin topic. The financial issue has already been agreed upon by all sides. The unions have already agreed to wage freezes and the governor’s proposed benefit cuts. The only issue on the table is the right to engage in collective bargaining over non-wage issues. Are you suggesting that eliminating collective bargaining rights in all 50 states would somehow fix the recession??? If not, then what is the relevance of your Wisconsin example?

  14. 2slugbaits

    Ed Hanson You want a coherent plan?… Deep and permanent reduction of marginal income tax rates were used in both instances and successfully brought a quick end to high unemployment with sustained high GDP growth.
    Oh my. In the 1981-82 recession we entered the recession with high interest rates, which gave the Fed a lot of room to cut. We came out of the recession once the Fed had decided inflation was wrung out of the economy and it loosened interest rates. And Reagan lowered the top rate from 70% to 50%, not 25%. The top rate was eventually lowered to 28%, but that didn’t go into effect until 1987, long after the recession was over. So I guess I’m still looking for some coherent alternative to ARRA. I agree that ARRA was not as effective as it needed to be. No surprise given that it needed to be almost twice as large as it was.

  15. Mark A. Sadowski

    Ed Hanson,
    I’m with 2slugbaits with respect to the 1981-1982 recession. It’s really explained by monetary policy not tax policy. One hint that this is so is the timing. I won’t go into the details of monetary policy of the period but it is useful to review the history of tax policy during that time.
    From May 1980 through October 1981 the unemployment rate was steady between 7 and 8 percent. Reagan signed ERTA into law in August and the first installment of his tax cut went into effect in October. The following month unemployment rose above 8 percent.
    The second installment of ERTA went into effect in July 1982. By this point unemployment had risen to 9.8%. In September of that year Reagan signed TEFRA into law. TEFRA was perhaps the largest tax hike in US history. It went into effect in October. Unemployment stabilized the following month at 10.8%, and the economy started its “morning in America” recovery.
    Reviewing the history of the 1981-82 recession it’s tempting to talk about contractionary tax cuts and expansionary tax hikes. Fiscal policy should have only very short lags following implementation, and the economy went into a deep recession after Reagan cut taxes and came out of it only after he raised them. But I don’t think correlation is causation in this case. That’s because the real story behind the 1981-82 recession is monetary policy.

  16. Ed Hanson

    Mark
    I can only answer with a history dealing with the interaction of monetary policy and fiscal policy, which is an expansion on your history. Sorry its long winded.
    The Great Inflation and its ending is great study of the interaction of fiscal and monetary policy. Throughout the 70’s as inflation pushed people into higher tax brackets, people were paying higher taxes without either a gain in prosperity or a vote from the legislature they could contest. The effect was not to work harder, take greater risk, but at the margin, a reduction of effort to earn that next dollar. When Volcker necessarily applied the brakes on money creation, which meant no longer maintaining a targeted FFR, the steep increase in interest rates quickly put the country into recession (the 1980 one) as business that relied on borrowed funds had to cut back. As anticipation of Reagan tax policy became clearer, business activity began to rise, and as the tax cuts became law, rose faster. Interest rates were coming back down, business activity was rising. However, leading indicators that Volcker was watching were indicating that inflation was reigniting. He had the choice, fight the psychological fear of the country of the Great Inflation returning, or to wait to see if the more robust economy would sop up excess money still in existence. He chose to hit the brakes hard, again driving up real interest rates far higher than the economy could manage. This was the cause of the 81 very steep recession. Fortunately, as you observe, fiscal policy should have a short lag, and this time, fortunately did. The deep 81 recession did have a short life, and as normal, had a rapid rise of GDP coming out of it.
    And I repeat, the rapid recovery is not what is happening this time.
    The history I have given is mostly from Robert Mundell, adapted by me with my understanding of Milton Friedman. An interesting period of expansionary fiscal tax policy and a contracting monetary policy.

  17. Ricardo

    Mark,
    UK VAT tax rate has been 17.5% since 1991 except for a short period from December 1, 2008 through March 31, 2010 when it was lowered to 15%. On April 1, 2010 it was returned to 17.5% then January 4, 2011 it was increased to 20.0%.
    Unlike the income tax, VAT is virtually impossible to avoid. Only those rich enough to leave the country can avoid the VAT. The VAT is collected by businesses but they pass it along to the purchaser. While it is not a regressive tax, because it doesn’t increase as income declines, it does reduce the disposable income of the poor and so they feel the impact more.
    This increase in VAT will have a serious impact on the British economy. Combined with the reductions in government spending and the British people are in for a very serious decline.
    What is sad is that the British government is not going to understand why Germany is growing while they decline. Like the Democrats and Republicans in the US they see solutions as either increased taxes or budget austerity. Both lead to economic decline. The Democrats need to look to John Kennedy and the Republicans need to look to Ronald Reagan. Economic growth is the only solution to our economic problems.
    See the numbers here.

  18. Ed Hanson

    Slugs, you wrote;
    First, the decisions of one state are not confined to that state alone. One of the lessons learned from the housing bust is that many states in the midwest that were not part of the housing boom nevertheless suffered some of the biggest losses in the Great Recession. Sometimes recessions reward the guilty and punish the innocent. What happens in Wisconsin doesn’t have to stay in Wisconsin.”
    The housing crisis has its roots in Federal Government policy which is mostly why its affects crossed state lines. And looking at the glass half full, if what happens in Wisconsin is a good thing, the good does not have to stay in Wisconsin.
    “Second, we already have a case study of what happens when the national government follows a policy like that of Britain or Wisconsin. It’s called 1937. Been there, done that, don’t need to relearn old lessons.”
    I suspect we have different opinions of the lessons from 37, but one thing is clear, mistakes by over powerful Federal government has countywide repercussions.
    “We know what happens when a country cuts back on spending and raises taxes during a recession.”
    Not a good thing, which is why I advocate lowering tax rates, not raising them as was the case of the first two years since the recession.
    “Are you suggesting that eliminating collective bargaining rights in all 50 states would somehow fix the recession???”
    No, I am saying that public workers already protected by civil service laws, or in the case of teachers by tenure rules, should not have union collective bargaining rights.

  19. Ed Hanson

    Get Rid the Fed, in response to (which I now have screwed up twice and can only hope the site moderators kill before they show up)
    “if it wasn’t for the demand deposits created from gov’t debt, was there going to be a shortage of the medium of exchange?
    Even if there isn’t a shortage of the medium of exchange in the recent past/present, could there be a shortage in the future because the composition is wrong?”

    I do not know. I consider TARP as necessary, although it was inefficient and somewhat corrupt. But I also consider the whole crisis as the fault of Federal government intervention in the market place that the Federal Reserve Bank accommodated, probably with little choice. I do agree with John Taylor that the Fed was too easy in the period up to 2005.
    Along with the tremendous asset contraction being experienced, comes strong, real deflationary pressure. But I do not think that monetary intervention is the cure, but believe that fiscal policy of higher incentives through lower supply side tax rate cuts is. Note that I do not support demand side stimulus that has been the response.
    As for the future, with all the money creation the Fed has made, no, I do not think there will be a shortage in the near future. I am curious about your use of the word ‘composition’. You must have some ideas about this, I would be interested in how you see this.

  20. Ricardo

    Mark,
    You are correct that the 1981-82 recession was due to monetary policy. Volker was warned that if he continued to contract the money supply after the Reagan tax cuts he would create a recession and that is exactly what happened.
    Volker had contracted the money supply based on monetarist theory and and sent the economy into a deflationary contraction. When the Mexican government informed the US that it could not meet its dollar obligations Volker finally broke with his monetarist methodology and gave the Mexicans $3billion. This ended the monetary contraction and the Reagan tax cuts manifest themselves in rapid economic growth.
    Had Volker listened in 1980 the US could have avoided the 1981-82 recession and started recovery 2 years earlier.

  21. Mark A. Sadowski

    @Ed Hanson,
    Let me just add the following about the about the recession of 1981-82. I believe that fiscal policy, and that includes tax policy, has a very limited ability to influence aggregate demand unless the central bank accomodates it. I also believe that lower marginal rates are conducive to higher long run growth but that is an entirely different matter from managing business cycles. ERTA may have been beneficial to long run growth but I seriously doubt it can be credited with the recovery from the 1981-82 recession. Contrary to what you are saying, the recession was one of the longest recessions in history, and it started only as ERTA went into effect. The recovery began nearly a year and a half after Reagan signed ERTA into law, and only after TEFRA went into effect, effectively canceling out much of ERTA at least in terms of overall revenue. The timing is completely wrong.
    More importantly I’d like address your view of the 1920-21 recession which have probably been influenced by Powell, Woods and Murphy.
    I’ve been reviewing the facts of the recession of 1920-21 and the timing for the role of tax policy is all wrong there as well. The recovery from the recession started in August 1921. The Revenue Act of 1921 was not signed into law by Harding until November and was not implemented until 1922. By the time the Revenue Act was passed industrial production had already risen over 10%, and by the time it was implemented it was up over 15%. Furthermore it’s not clear that the Revenue Act of 1921 was really a tax cut. The top rate was reduced from 73% to 58% but the base at that rate was broadened from all income over $1,000,000 to all income over $200,000. The average effective tax rate actually rose from 3.7% to 4.0%.
    The recession of 1920-21 is a complicated story involving a shift from a wartime to peacetime production and sudden deflation in the price goods that were severely inflated during the war (clothing and food). But I think it’s clear that monetary policy was the primary driver in both the recession and the subsequent recovery.
    The discount rate was the policy instrument in those days. It was raised from 4.5% in January 1920 to 7% in July 1920. The recession started in January but industrial production didn’t begin its swift decline until August. The discount rate was reduced steadily to 4.5% between April and December 1921, and it was further reduced to 4% by July 1922. Although technically the recovery began in August, industrial production didn’t begin to recover in earnest until October. It’s fairly well established that monetary policy lags were somewhat shorter in the pre-WW II period.
    A good paper that sets the record straight on the 1920-21 recession is here (paid content unless you’re associated with a university):
    http://www.springerlink.com/content/5683j4v650187261/
    @ricardo
    I like economic growth just as much as I like mom, apple pie, hot dogs and Chrysler Imperial. The question is how to get it. It’s important to separate demand from supply side issues. I think what we are suffering from right now is an insufficiency of aggregate demand. Tax cuts are probably worth little more than diddly squat in such a situation. What we really need is more monetary stimulus.
    And your link doesn’t work.

  22. 2slugbaits

    Ed Hanson The housing bust had its roots in the absence of federal government involvement, not too much.
    As to collective bargaining rights for public sector employees, I’m wondering if you actually know what kinds of things are normally covered. The main purpose of collective bargaining rights for public sector workers is protection from abusive bosses. The kinds of things that are typically covered usually include minimum hours between shifts, definitions of normal work hours, independent enforcement of safety policies, use of sick leave to care for dependents, bereavement leave, etc. That may not track with the private sector’s understanding of collective bargaining between management and private sector unions, but there you go. Private sector employees have fewer constraints on quitting their jobs, so I don’t think it’s unreasonable for public sector workers to expect protection from abusive bosses. Look, for the most part abusive bosses in the public sector are not a huge problem, so it’s not like collective bargaining imposes huge costs. But in Gov Walker’s case it’s pretty obvious that this guy has some ego and power issues…the kind of guy who probably would be an abusive boss if given half a chance. I’m sure you know the type.

  23. 2slugbaits

    Ricardo The Democrats need to look to John Kennedy and the Republicans need to look to Ronald Reagan. Economic growth is the only solution to our economic problems.
    Well, it’s hard to argue with the need for economic growth. The question is how do you grow the economy. There are times when the binding constraint on economic growth is a stiff aggregate supply curve. And over the long run we want to favor policies that reward productivity and technological ingenuiety. But that’s not today’s problem. Today’s problem is weak aggregate demand and too much global savings. If you want to reduce the long term burden of government debt, then we better pony up much bigger deficits in the short run in order to kick start the economy. I’m concerned that this halfway stuff that we’re doing today is leading to deficits that are big enough to cause problems but not big enough to do the job. As a result we’re apt to end up with the worst of all possible worlds…endless deficits and no growth. That’s what we’re going to get if Boehner and Cantor and Pence are allowed to have their way.

  24. Ed Hanson

    Mark
    I enjoy your post and believe I have recently learned from each one. But that said, it is time for disagreement.
    Let’s start with
    “Let me just add the following about the about the recession of 1981-82. I believe that fiscal policy, and that includes tax policy, has a very limited ability to influence aggregate demand”
    I agree but not the way you think. Good tax policy change has great ability to influence supply and that is the measure of wealth. Unlike it seems the way you were taught and believe, Supply creates its own demand, but not the other way around. Aggregate demand is a result not a controlling factor
    I compliment you on your research of time lines. The accuracy is helpful. But (you knew that was coming), you are wrong about when business, and people and the economy in general react to these changes. Business must anticipate general economic environment, that is plan for the future. No way do they wait until the actual changes. The election had Harding campaigning on “Return to Normalcy” which meant among other, being that it was two years since the end of the war, it was time to end high war taxes. When Harding won, it became a given, tax rates would go down. You should note people do look to the future and anticipate it, tax policy changes can work early and quickly to counter recession.
    Finally, to the 82 recession. First a quibble, there were 5 recessions in the 20th century of longer duration, which I believe better puts a perspective on that issue. However, I wish to concentrate on the four recessions of the last 100 years. ’20-’21, ’29-’33, ’81-’82, and ’07-’09. Each of these recessions had the sharpest decreases in GDP as well as associated unemployment above 10%. Two had the fortune to be ended by deep and meaningful tax rate cuts, and two were met with tax increases and increased deep and harmful government regulation. The worse, by Hoover, FDR had the greatest tax rate increase as well as profound new government interference in the market, and the second worse Bush, Obama had milder but still tax increases, but compares with Hoover, FDR on regulation and interference. The result of Hoover, FDR was a long depression with high unemployment, and Bush, Obama is only at best, a very anemic and slow recovery with high unemployment. The two best, Harding and Reagan led to robust years of good growth and return of employment.

  25. Mark A. Sadowski

    Ed Hanson,
    I’m attempting to convert you to my point of view (but I know to no avail). I am a monetarist with supply side convictions. Lower marginal rates are fine, but aggregate demand matters a great deal more than you evidently imagine.
    You wrote:
    “Supply creates its own demand, but not the other way around. Aggregate demand is a result not a controlling factor.”
    I believe this is absolutely backwards. Demand creates its own supply, for without demand supply has absolutely no incentive. The controlling factor is always demand. History has proved that again and again (with each succeeding and totally unnecessary depression).
    Expectations are always a factor. That’s why it’s so dumbfounding you would think the expectation of Reagan’s changes had such a profound effect on the economy. When Reagan took office unemployment was high being in the mid 7% range but hardly a disaster. By late 1982, nearly two years into his presidency he managed to set a record (10.8%) for the worst unemployment rate performance since Hoover. So much for the power of expectations. (By the way, I’m not arguing from readings, I was actually there.)
    And your recollection of the historical record is somewhat defective. The most rapid peacetime economic growth in the entire history of the US occurred from 1933 through 1941. Real GDP nearly doubled in 8 years. There is no comparable period in terms of economic growth for the United States, and nor will there ever be in my lifetime, even if I live to be 250 years old.

  26. Mark A. Sadowski

    Ed Hanson,
    Another important distinction. The recovery from the 1920-21 recession and the 1981-82 recession took place under conditions where the Wicksellian rate was high so monetary stimulus was relatively easy. The Great Depression and the current recession are the opposite. The failure to adjust for context is telling.

  27. Ed Hanson

    Mark
    Fascinating, I have labeled myself as a supply-side monetarist, a very lonely description in the economic circles I have been in for the last 15 years. In fact you are the first I exchange ideas with who comes close to the same moniker.
    Would you care to answer some questions as to who you regard as who influenced your economic leanings.
    Which monetarist(s) has influenced you the greatest?
    For me it essentially is Milton Friedman, so much so, there is little anyone else. I admire John B. Taylor, but he does not have near the breadth of thought as Friedman; but who does.
    Who are your supply side influences.
    I attempt to follow the teachings of Robert Mundell, although I vehemently disagree on fixed exchange rates. I find Rueven Brenner extremely insightful, as well as Art Laffer. And I first began the supply side journey reading The Way the World Works by Jude Wanniski.
    I certainly would add to the list, if you so accommodate.
    And by the way, I was there in the 80’s, also during the Great Inflation, and remember Kennedy reasonably well. And am surprised at your seemingly dismissal of the potency of supply side tax rate cuts, at any time depending on the ideas behind the Laffer Curve.

  28. Ed Hanson

    Mark
    “Another important distinction. The recovery from the 1920-21 recession and the 1981-82 recession took place under conditions where the Wicksellian rate was high so monetary stimulus was relatively easy. The Great Depression and the current recession are the opposite. The failure to adjust for context is telling.
    I do not think the the situations are that much different. While it is true going into each of the recessions, nominal interest rates were quite different, the asset destruction of 29 and 07 made real rates quite high as they were in 20 and 82, leading me to consider the similarities closer. But regardless, the fiscal solution is the same, for high inflation times, reduce tax rates and increase the demand and use of the excess money, and in asset destruction times, reduce tax rates and increase the demand for those assets.
    Aside from monetary policy to facilitate ‘lender of last resort’ to save a failing banking system, additional monetary additions to the economy are harmful.
    In today’s policy to counter the recession, what was happening. A promise of substantial rise of tax rates, small additional taxes, greater Government programs, terrible new regulation, and finally hidden taxation (but just as real) of government borrowing without end.

  29. Mark A. Sadowski

    Ed,
    These are my truthful answers not at all intended to make fun of your honest questions.
    You wrote:
    “Which monetarist(s) has influenced you the greatest?”
    Scott Sumner of Bentley University and of “The Money Illusion”. He has steered me slowly but irrevocably towards the idea that monetary policy determines AD.
    And you wrote:
    “Who are your [greatest] supply side influences.”
    Myself. My own as yet unpublished research shows the truth (in my opinion) in terms of tax structure and economic growth. My policy recommendations are the following:
    1) Eliminate all corporate and capital gains taxation.
    2) Raise revenue using (progressive) consumption taxes (which includes even the VAT).
    By the way I’m an almost PhD economist. What are you?

  30. Ed Hanson

    An old engineer who is now doing home remodeling.
    When you say you are almost a PhD, does that mean you are still moving toward it formally? If so I think an old guy like you still treading the pure education route is commendable.
    I find Sumner quite interesting as someone who certainly thinks outside the box, which is quite important, but he has a ways to go.
    How would you institute a progressive consumption tax? And what about individual income taxes?
    Mark, I don’t mind personal questions, heck, I started it, but this is Menzie’s and James’s place. Do you have a different venue? I have one, or email is just find when we get off the subject of this site.

  31. Ricardo

    Mark Sadowski wrote:
    …over the long run we want to favor policies that reward productivity and technological ingenuiety. But that’s not today’s problem. Today’s problem is weak aggregate demand and too much global savings. If you want to reduce the long term burden of government debt, then we better pony up much bigger deficits in the short run in order to kick start the economy.
    Mark,
    Spoken like a true Keynesian believer.
    Can you give me an example of when this has worked?
    I do agree with you that the government focus on reducing the constraints on real estate created a dislocation of demand and resources and that today there is weak demand because resources have been wasted through malinvestment. Where we disagree is the solution to the problem. Our current problem is excessive government spending and government debt at the expense of the productive economy.
    Two things are needed to repair the malinvestment. First, production in areas demanded by the market needs to recover so that prosperity will change some malinvestment into valid investment. Second, malinvestment that cannot be recovered needs to be priced at a real value. This may mean that some malinvestment is simply lost. For example cement used for buildings or other construction that will never be completed. This is perhaps the greatest destruction of government policies stimulating demand in areas not demanded by the market. Such stimulation always destroys resources.

  32. Get Rid of the Fed

    “Along with the tremendous asset contraction being experienced, comes strong, real deflationary pressure. But I do not think that monetary intervention is the cure, but believe that fiscal policy of higher incentives through lower supply side tax rate cuts is. Note that I do not support demand side stimulus that has been the response.”

    What if there is mostly enough supply? Other than cheap oil and maybe food at times, what is in short supply?

    “As for the future, with all the money creation the Fed has made, no, I do not think there will be a shortage in the near future. I am curious about your use of the word ‘composition’. You must have some ideas about this, I would be interested in how you see this.”

    I was referring to demand deposits because they can be defaulted on and/or paid off.

    I see about 1 trillion in currency and about 58 trillion in the demand deposits created from debt, whether private or gov’t. Can that lead to problems?

  33. Get Rid of the Fed

    “Mark Sadowski wrote:
    …over the long run we want to favor policies that reward productivity and technological ingenuiety. But that’s not today’s problem. Today’s problem is weak aggregate demand and too much global savings. If you want to reduce the long term burden of government debt, then we better pony up much bigger deficits in the short run in order to kick start the economy.”

    So you are saying this is an aggregate demand shock and NOT an aggregate supply shock?

    Does the reward involve more debt?

  34. Get Rid of the Fed

    Ricardo said: “Where we disagree is the solution to the problem. Our current problem is excessive government spending and government debt at the expense of the productive economy.”

    I’m of the opinion that too much debt is the problem, whether private and/or gov’t.

  35. 2slugbaits

    Ricardo Can you give me an example of when this has worked?
    Sure. How about World War 2? Or scroll above to see CBO’s analysis of ARRA. Doesn’t that count as an example? If you have an NBER subscription you might want to check out “Measuring the Output Responses to Fiscal Policy”:
    http://www.nber.org/papers/w16311
    today there is weak demand because resources have been wasted through malinvestment. Where we disagree is the solution to the problem. Our current problem is excessive government spending and government debt at the expense of the productive economy
    Spoken like a true Austrian. You’ll grow out of it.

  36. Ed Hanson

    Ricardo is correct, The recent crisis is an Austrian business cycle of the collapse of mal-investment.
    And this occurred because the government decided that a greater increase in the rate of individually owned housing was good public policy. It created programs which subsidized mortgage loans by facilitating mortgage rates at less than the natural rate. It regulated the reduction of the traditional 20% down to lesser amounts. Its programs told lenders to find the means to reduce mortgage payments so more could qualify, so accepted variable rate loans where the initial low payment could be used to qualify a loan. Need I mention liar loans and no down payment loans. And as the run up to the crisis grew near, the Fed became easier in its money creation, per an excellent analysis from John Taylor, et al.
    Classic Austrian mal-investment criteria.
    And fiscal stimulus such as ARRA is not a solution. Nor is the series of QE going to do anything beyond the short term Phillips effect, with a subsequent penalty to the economy.

  37. Mark A. Sadowski

    Ed Hanson,
    I don’t mind personal questions. I’m (hopefully) defending my dissertation this semester. It’s a second career for me.
    With respect to a progressive consumption tax I would institute it as a progressive payroll tax for simplicity sake.
    I’m an email person.
    Ricardo wrote:
    “Mark Sadowski wrote:
    …over the long run we want to favor policies that reward productivity and technological ingenuiety. But that’s not today’s problem. Today’s problem is weak aggregate demand and too much global savings. If you want to reduce the long term burden of government debt, then we better pony up much bigger deficits in the short run in order to kick start the economy.”
    I didn’t write that. I suspect 2slugbaits did. I agree with the part about AD. But I’m no longer a big fan of fiscal stimulus. What are you smoking?
    @Get Rid of the Fed
    See the above.

  38. Get Rid of the Fed

    Sorry, Mark. I just copied from above.

    IMO, there was an aggregate supply shock that was not handled correctly and later showed up as an aggregate demand shock.

  39. Get Rid of the Fed

    Ed Hanson, was the housing bubble used to prevent price deflation?

    And, does that mean the solution to too much lower and middle class debt is not more lower and middle class debt and not more gov’t debt?

  40. Ed Hanson

    Get Rid of the Fed
    Your questions are getting a little obscure. I suspect you have your own answers to them. Just publish them.

  41. Mark A. Sadowski

    Get Rid of the Fed,
    You wrote:
    “IMO, there was an aggregate supply shock that was not handled correctly and later showed up as an aggregate demand shock.”
    That depends on what you mean by handled properly. There was probably a modest negative AS shock due to the shift away from housing construction and the rise in energy prices. This showed up as a weaker economy and rising headline inflation in early 2008 (a little case of stagflation). But depite all that the economy was not doing too badly with unemployment being less than 6%.
    What happened next has all the symptoms of a massive negative AD shock with rapidly declining inflation expectations, rising exchange rates, falling stock prices, falling commodity prices, falling real estate prices where there was no hint of a “bubble” previously, etc.
    Quasimonetarists like Sumner, Beckworth, Wooley, Nunes, Selgin etc. believe that the key to macroeconomic stability is to target nominal expenditure levels and totally ignore AS shocks (negative or positive). One problem with inflation rate targeting is illustrated by what happened in 2008. The Fed allowed NGDP to falter. (and the ECB did even worse). We tightened up during a moderately negative AS shock and set off what some might call a massive “secondary deflation” (a la Hayek).
    The BOE is in the process of repeating this very mistake as we speak.

  42. Get Rid of the Fed

    Mark said: “There was probably a modest negative AS shock due to the shift away from housing construction and the rise in energy prices.”

    Actually, I was thinking a positive AS shock from free trade and other things.

  43. Get Rid of the Fed

    Ed Hanson, I was trying to get your ideas about debt.

    I believe the fed intentionally (although I wasn’t sure at the time if it was intentional or not) “blew” a housing bubble to get people to spend in the early to mid 2000’s.

  44. Get Rid of the Fed

    Mark said: “Quasimonetarists like Sumner, Beckworth, Wooley, Nunes, Selgin etc. believe that the key to macroeconomic stability is to target nominal expenditure levels and totally ignore AS shocks (negative or positive). One problem with inflation rate targeting is illustrated by what happened in 2008. The Fed allowed NGDP to falter.”

    I believe NGDP targeting and price inflation targeting suffer the same flaw. They both want all new medium of exchange to be the demand deposits created from debt, whether private or gov’t.

    Along the same lines, I believe real aggregate demand is limited (not unlimited). If the population is growing about 1% per year and there is enough supply of most goods/services making real GDP growth about 1% per year, what happens to employment if productivity is growing about 2.5% to 3% a year?

  45. Mark A. Sadowski

    Get Rid of the Fed (aka Fed Up),
    A positive AS shock would manifest itself in increasing output growth and a decreasing inflation rate. There hasn’t been such an event since the late 1990s.
    If I remember correctly you have your own personal definitions of monetary aggregates that makes it difficult to have a conversation. The monetary base esentially consists of bank reserves and currency. Enlarging the monetary base doesn’t entail creating more debt.
    By definition AD is the total demand for final goods and services in the economy at a given price level. Thus “real aggregate demand” is a contradiction in terms. And just as the price level is unlimited, so is AD.

  46. 2slugbaits

    Mark A. Sadowski Replying to Ricardo you said: I didn’t write that. I suspect 2slugbaits did. I agree with the part about AD. But I’m no longer a big fan of fiscal stimulus.
    Yes, I wrote that. But just to be clear, ordinarily monetary policy should be the preferred tool for managing recessions; however, in the current context conventional monetary policy has reached its limit with ZIRP and it is unclear if unconventional monetary policy has the punch we need. So that leaves us with fiscal policy. In a perfect world it would not be my first choice, but we know it will work if the fiscal stimulus is big enough.

  47. Mark A. Sadowski

    2slugbaits,
    I used to believe that monetary policy is less potent in ZIRP but I’ve changed my mind. As long as the Fed credibly commits to a nominal target nothing can stop it from getting where it wants to go. (After all it has the printing press.)
    The problem is that the Fed has fallen under the spell of hawks like Plosser and Hoenig. Thus not only do I think fiscal stimulus is unnecessary (and therefore undesirable), but that the hawks essentially neutered ARRA, and unless something changes, would counteract any future fiscal stimulus.
    But, other than that major caveat, I don’t think we are that far apart.
    P.S. Menzie has written a really good paper on NGDP level targeting. I sometimes wonder why he doesn’t try to sell the concept more.

  48. Get Rid of the Fed

    Mark said: “A positive AS shock would manifest itself in increasing output growth and a decreasing inflation rate. There hasn’t been such an event since the late 1990s.”

    What happened when china got official WTO entry?

    If there is increasing output growth and decreasing price inflation, does the amount of medium of exchange in the real economy (meaning central bank reserves don’t count because they can’t be used outside the banking system covered by the fed) need to rise to prevent price deflation?

  49. Get Rid of the Fed

    Mark said: “By definition AD is the total demand for final goods and services in the economy at a given price level. Thus “real aggregate demand” is a contradiction in terms. And just as the price level is unlimited, so is AD.”

    So when I try to say that AD is not unlimited and scott sumner says what about zimbabwe, what definition is he using?

    If the fed gives Warren Buffett $100,000 in currency and he doesn’t spend it because he has enough; doesn’t invest it because he doesn’t like the prices and/or opportunites right now; and does not retire, what should that be called?

  50. Get Rid of the Fed

    Mark said: “If I remember correctly you have your own personal definitions of monetary aggregates that makes it difficult to have a conversation. The monetary base esentially consists of bank reserves and currency. Enlarging the monetary base doesn’t entail creating more debt.”

    I believe enlarging central bank reserves but trying not to increase currency very much is mostly about more debt.

    Are there examples where the amount of medium of exchange fell because the amount of demand deposits fell while currency and/or central bank reserves rose?

  51. Mark A. Sadowski

    Get Rid of the Fed,
    You wrote:
    “What happened when china got official WTO entry?”
    Nothing discernable. The positive AS shock had already occurred.
    And you wrote:
    “If there is increasing output growth and decreasing price inflation, does the amount of medium of exchange in the real economy (meaning central bank reserves don’t count because they can’t be used outside the banking system covered by the fed) need to rise to prevent price deflation?”
    Not necessarily. Aggregates really don’t matter. But the results do. (And, central banks don’t face a reserve requirement by definition.)
    You wrote:
    “So when I try to say that AD is not unlimited and scott sumner says what about zimbabwe, what definition is he using?”
    There’s only one definition of AD. Sumner’s using the only one there is.
    And you wrote:
    “If the fed gives Warren Buffett $100,000 in currency and he doesn’t spend it because he has enough; doesn’t invest it because he doesn’t like the prices and/or opportunites right now; and does not retire, what should that be called?”
    The Fed doesn’t give out currency. It buys stuff with currency. But if it buys some of Warren Buffet’s stuff and he chooses to bury it in his mattress that suggests that buying Buffett’s stuff was a bad idea from the standpoint of stimulating AD.

  52. Ed Hanson

    Get Rid of the Fed
    I can’t imagine trying to get all my ideas about debt in these posts. So I will try to limit it to a side issue. I do not blame the Fed for the housing bubble. Did they accommodate it, yes, but I do not think it was its target. In fact I do not know why the Fed was doing what it was doing 2003 to 2005. I think part of the ease was a holdover from the damage of 9/11. And I think much of it was the transition from Greenspan to Bernanke. Greenspan may have finally have let the Maestro syndrome effect him. But what ever the reason, Taylor has a quite convincing research showing the Fed remained easier than the Taylor Rule would put them, and that was a change from the 90’s when it seemed to follow the rule closely.
    But all said, it was the Federal Government whose laws and regulation was the driving force. It created so many programs to enhance, subsidize, and coerce housing ownership, I know I forgotten some. The biggest was the lifetime tax free profit for most home sales, which then change to every two years. Add to that the banking regulation pressure on banks to provide loans to people whose income simply did not qualify. Then Fanny May and Freddy Mac competing for relevancy and being an absolute source to buy these sub par loans. Everybody was happy until the piper had to be paid. But remember this, all sorts of government agencies had more to do with the bubble than did the Fed itself.
    As for debt from deficits, there is no doubt at all, that the deficit was going huge at the start of the recession. But unfortunately, the powers that be decided to run up the deficit through government command economy. It should have caused the deficit by placing greater resources into the hands of those who earn the wealth of the country, the ordinary citizen, by solid and large supply side tax rate cuts. Marginal tax rates, reduced capital gain treatment, and very large reduction of corporate income taxes. (zero would have been great for the last two). That would have created great growth that would have seen the deficits come quickly down, not the trillion dollar ones we now see forever.
    I am all for spending cuts, heck, I would love to see the country return to the limited government it was designed but realistically the only way this country can get out of the mess is sustained high growth. With the present President, I have no hope.

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