Economics One

Simulations of Mark Zandi’s economic model, which are reported in the press to show that a new temporary stimulus package will create 1.9 million jobs, are being touted as evidence that it will work. This is the same type of model simulation that predicted the very similar 2009 stimulus package would create millions of jobs, and the same type of simulation that claimed that that package worked. Andrew Ferguson reviews the predictions in a recent article in Commentary.But simulations of such models do not provide such evidence, as I have explained on this blog before, for example here and here. They are wrong because they assume “multipliers” for temporary one-time payments or tax changes far in excess of the basic “permanent income” or “life cycle” models (which we teach in Economics 1). They are wrong because they assume that state and local government infrastructure and other purchases respond to federal stimulus grants in a mechanical way, unlike what we have seen practice, as I explained in this article with John Cogan. And they are wrong because they do not take account of the negative growth effects of expected future permanent increases in tax rates. I have debated Mark Zandi on these topics many times before, for example on the NewsHour and in congressional testimony.

However, the terribly weak economic recovery has forced an important change in the way that these predictions are put forward by modelers like Zandi. They have to admit that even their exaggerated estimated impacts of the temporary stimulus packages are, yes, temporary. Macroeconomic Advisers reports the same thing: “the GDP and employment effects are expected to be temporary” and more specifically that “these proposals will pull forward increases in GDP and employment, not permanently raise their level.”

In other words, even if, on balance, jobs are created by the package (which is doubtful), they will be destroyed as soon as the temporary package is over, according to Zandi. Thus even the promoters of such temporary packages agree that they will not jump-start the recovery, which is what is needed to really reduce unemployment.

Perhaps more than anything else, this is the reason why we need to do something besides “more of the same,” and instead follow the wisdom put forth in this speech (video, transcript)  by George Shultz upon winning the first Economic Club of New York Award for Leadership Excellence this past week.

Congress was busy working on fiscal policy today. This morning, over on the House side, it held its first hearing on President Obama’s fiscal stimulus proposal. As one of the witnesses, I argued that the fiscal policy responses thus far to the unemployment problem have not been effective. Consisting mainly of short-term temporary and targeted interventions, the policy has not had a sustainable impact on economic growth and unemployment. Instead, the policy has increased the federal debt and raised uncertainty, which is an impediment to economic growth. Unfortunately, the proposals made by President Obama on September 8 consist largely of the same type of temporary and targeted interventions that have been tried for the past several years. Recent experience and past experiences show that this type of fiscal policy will not increase economic growth, certainly not on a sustained basis. It will not therefore bring the unemployment rate down to pre-recession levels which should now be the goal of policy.

Over on the Senate side this afternoon, there was a hearing on more comprehensive tax and budget reform. I testified there too, along with Alan Greenspan and Martin Feldstein.  I briefly laid out a more permanent and predictable alternative to the President’s temporary and targetted proposal—a budget strategy to raise economic growth with revenue-neutral tax reform. It builds on the Budget Control Act and brings spending to the level of 2007 as a share of GDP.

Here is my New York Times oped Not More of the Same on why it is urgent to change the course of economic policy.

My critique of Keynesian countercyclical policy, which is summarized in the NYT article, has been challenged by Fred Bergsten of the Peterson Institute who said at the Jackson hole meeting last week that the Reagan tax cut is an example of a countercyclical policy that successfully stimulated the economy, and therefore disproves my case.   But as Larry Summers famously described it, Keynesian countercyclical policy is “temporary, targeted, and timely.”  The Reagan tax cut was certainly not temporary. And it wasn’t targeted either; it was across the board. And it wasn’t timely because it lasted well beyond the recession and the recovery. In fact, it is just the kind of “permanent, pervasive, and predictable” policy that we need now. 

In the meantime, an article in the New York Times over the weekend suggested that there was a new consensus for the view which Joe put forward. I see no such consensus. Some economists such as Joe, Paul Krugman, and Robert Reich have that view, but that is not new for them. And it is nothing new for Warren Buffett to argue for tax increases as he did in an New York Times op-ed today: When he was an adviser to Arnold Schwarzenegger in the 2003 California recall election, Buffett recommended tax increases, but Arnold told him to cool it or do 500 pushups for punishment. And there are plenty of economists who think that gradually reducing spending and not increasing taxes is better for job creation.  In June, for example, 150 economists (including me) wrote that a debt deal “that is not accompanied by significant spending cuts and budget reforms would harm private-sector job growth”