Media reports suggest President Trump and Democratic leaders have agreed in principle to a $2 trillion infrastructure plan “to upgrade the nation’s highways, railroads, bridges and broadband.”
Minor details such as how to finance it have yet to be agreed. White House Chief of Staff Mick Mulvaney doubts the deal will come to fruition anyway, given differences between the parties on environmental regulations surrounding new projects.
But it’s difficult to think of a worse way to make major policy than to dream up a big round number and then work backwards in deciding how money is spent.
Indeed, if $2 trillion is the answer, then what, exactly, is the economic question?
Is $2 trillion the amount needed to invest in targeted public goods that the market would not or could not provide? Is $2 trillion the amount the politicians think is needed for specific projects to enhance long-term economic growth? Is $2 trillion the amount politicians feel is necessary to repair existing infrastructure? Is $2 trillion what they feel the federal infrastructure contribution needs to be to alleviate negative externalities such as pollution? Or is $2 trillion maybe what they think is necessary to create shovel ready jobs to minimize unemployment?
Judging by the joint post-meeting statement from Speaker Pelosi and Senator Schumer, the Democrats have no coherent answer here. Within their 224-word statement, they outlined no fewer than 9 distinct policy aims or ambitions that any infrastructure package would be trying to meet:
- “creating jobs immediately”
- “bolstering commerce”
- “advancing public health with clean air and clean water”
- “improving the safety of our transportation”
- “expanding broadband to…underserved areas”
- “being for the future”
- paying “the prevailing wage”
- involving “women, veteran and minority-owned businesses in construction”
- addressing needs in “every congressional district”
Whatever the economic case for a major infrastructure program (and for my thoughts on that, read here), it should be obvious that these aims contradict one another.
Lots of projects with high returns take extensive planning and won’t “create jobs immediately.” Investment in safety might come at the expense of other projects that bolster commerce. Paying “the prevailing wage” will likely leave fewer resources to address needs in more districts. Selecting contractors based on the demographics of the owners might trade-off the safety quality of the job. Focusing on safety upgrades for existing infrastructure means fewer resources for “the future.” Addressing needs in every district and expanding rural broadband is almost certainly not the best way to bolster overall commerce. I could go on.
This plethora of aims is grist to the mill for a conclusion I reached back in 2017:
The sad truth is that infrastructure investment through the political process rarely prioritises long-term growth. Other considerations dominate, whether electoral advantage or regeneration of an area – even when market signals point to the need to expand booming regions.
The conflicted role of being both the promoter of a project and being responsible for examining its failures and risks leads politicians to make over-optimistic claims about a scheme’s benefits relevant to costs.
In principle, smart investments in infrastructure can sometimes improve economic welfare. But when huge amounts of federal money is seen as a communal pot for a host of social, environmental, local and “make work” objectives, the chances that such money will be spent wisely looks slim.
To be blunt, Republicans are heading in the wrong direction on fiscal policy. They have full control of the executive and legislative branches, but instead of using their power to promote Reaganomics, it looks like we're getting a reincarnation of the big-government Bush years.
As Yogi Berra might have said, "it's déjà vu all over again."
Let's look at the evidence. According to The Hill, the Keynesian virus has infected GOP thinking on tax cuts.
Republicans are debating whether parts of their tax-reform package should be retroactive in order to boost the economy by quickly putting more money in people’s wallets.
That is nonsense. Just as giving people a check and calling it "stimulus" didn't help the economy under Obama, giving people a check and calling it a tax cut won't help the economy under Trump.
Tax cuts boost growth when they reduce the marginal tax rate on productive behavior such as work, saving, investment, or entrepreneurship. When that happens, people have an incentive to generate more income. And that leads to more national income, a.k.a., economic growth.
Borrowing money from the economy's left pocket and then stuffing checks (oops, I mean retroactive tax cuts) in the economy's right pocket, by contrast, simply reallocates national income.
Indeed, this is one of the reasons why the economy didn't get much benefit from the 2001 Bush tax cut, especially when compared to the growth-oriented 2003 tax cut. Unfortunately, Republicans haven't learned that lesson.
Republicans have taken steps in the past to ensure that taxpayers directly felt the benefits of tax cuts. As part of the 2001 tax cuts enacted by President George W. Bush, taxpayers received rebate checks.
The article does include some analysis from people who understand that retroactive tax cuts aren't economically beneficial.
...there are also drawbacks to making tax changes retroactive. ...such changes would add to the cost of the bill, but would not be an effective way to encourage new spending and investments. “It has all of the costs of the tax cuts but none of the economic benefits,” said Committee for a Responsible Federal Budget President Maya MacGuineas, who added that “you don’t make investments in the rear-view mirror.”
I'm not always on the same side as Maya, but she's right on this issue. You can't encourage people to generate more income in the past. If you want more growth, you have to reduce marginal tax rates on future activity.
By the way, I'm not arguing that there is no political benefit to retroactive tax cuts.
If Republicans simply stated that they were going to send rebate checks to curry favor with voters, I'd roll my eyes and shrug my shoulders.
But when they make Keynesian arguments to justify such a policy, I can't help but get upset about the economic illiteracy.
Speaking of bad economic policy, GOPers also are pursuing bad spending policy.
Politico has a report on a potential budget deal where everyone wins...except taxpayers.
The White House is pushing a deal on Capitol Hill to head off a government shutdown that would lift strict spending caps long opposed by Democrats in exchange for money for President Donald Trump’s border wall with Mexico, multiple sources said.
So much for Trump's promise to get tough on the budget, even if it meant a shutdown.
Instead, the back-room negotiations are leading to more spending for all interest groups.
Marc Short, the White House’s director of legislative affairs, ...also lobbied for a big budget increase for the Pentagon, another priority for Trump. ...The White House is offering Democrats more funding for their own pet projects.
The only good news is that Democrats are so upset about the symbolism of the fence that they may not go for the deal.
Democrats show no sign of yielding on the issue. They have already blocked the project once.
Unfortunately, I expect this is just posturing. When the dust settles, I expect the desire for more spending (from both parties) will produce a deal that is bad news. At least for those of us who don't want America to become Greece (any faster than already scheduled).
Republican and Democratic congressional aides have predicted for months that both sides will come together on a spending agreement to raise spending caps for the Pentagon as well as for nondefense domestic programs.
So let's check our scorecard. On the tax side of the equation, we'll hopefully still get some good policy, such as a lower corporate tax rate, but it probably will be accompanied by some gimmicky Keynesian policy.
On the spending side of the equation, it appears my fears about Trump may have been correct and he's going to be a typical big-government Republican.
It's possible, of course, that I'm being needlessly pessimistic and we'll get the kinds of policies I fantasized about in early 2016. But I wouldn't bet money on a positive outcome.
Although it doesn't get nearly as much attention as it warrants, one of the greatest threats to liberty and prosperity is the potential curtailment and elimination of cash.
As I've previously noted, there are two reasons why statists don't like cash and instead would prefer all of us to use digital money (under their rules, of course, not something outside their control like bitcoin).
First, tax collectors can't easily monitor all cash transactions, so they want a system that would allow them to track and tax every possible penny of our income and purchases.
Second, Keynesian central planners would like to force us to spend more money by imposing negative interest rates (i.e., taxes) on our savings, but that can't be done if people can hold cash.
To provide some background, a report in the Wall Street Journal looks at both government incentives to get rid of high-value bills and to abolish currency altogether.
Some economists and bankers are demanding a ban on large denomination bills as one way to fight the organized criminals and terrorists who mainly use these notes. But the desire to ditch big bills is also being fueled from unexpected quarter: central bank’s use of negative interest rates. ...if a central bank drives interest rates into negative territory, it’ll struggle to manage with physical cash. When a bank balance starts being eaten away by a sub-zero interest rate, cash starts to look inviting. That’s a particular problem for an economy that issues high-denomination banknotes like the eurozone, because it’s easier for a citizen to withdraw and hoard any money they have got in the bank.
Now let's take a closer look at what folks on the left are saying to the public. In general, they don't talk about taxing our savings with government-imposed negative interest rates. Instead, they make it seem like their goal is to fight crime.
Larry Summers, a former Obama Administration official, writes in the Washington Post that this is the reason governments should agree on a global pact to eliminate high-denomination notes.
...analysis is totally convincing on the linkage between high denomination notes and crime. ...technology is obviating whatever need there may ever have been for high denomination notes in legal commerce. ...The €500 is almost six times as valuable as the $100. Some actors in Europe, notably the European Commission, have shown sympathy for the idea and European Central Bank chief Mario Draghi has shown interest as well. If Europe moved, pressure could likely be brought on others, notably Switzerland. ...Even better than unilateral measures in Europe would be a global agreement to stop issuing notes worth more than say $50 or $100. Such an agreement would be as significant as anything else the G7 or G20 has done in years. ...a global agreement to stop issuing high denomination notes would also show that the global financial groupings can stand up against “big money” and for the interests of ordinary citizens.
Summers cites a working paper by Peter Sands of the Kennedy School, so let's look at that argument for why governments should get rid of all large-denomination currencies.
Illegal money flows pose a massive challenge to all societies, rich and poor. Tax evasion undercuts the financing of public services and distorts the economy. Financial crime fuels and facilitates criminal activities from drug trafficking and human smuggling to theft and fraud. Corruption corrodes public institutions and warps decision-making. Terrorist finance sustains organisations that spread death and fear. The scale of such illicit money flows is staggering. ...Our proposal is to eliminate high denomination, high value currency notes, such as the €500 note, the $100 bill, the CHF1,000 note and the £50 note. ...Without being able to use high denomination notes, those engaged in illicit activities – the “bad guys” of our title – would face higher costs and greater risks of detection. Eliminating high denomination notes would disrupt their “business models”.
In other words, should we trade liberty for security?
From a moral and philosophical perspective, the answer is no. Our Founders would be rolling in their graves at the mere thought.
But let's address this issue solely from a practical, utilitarian perspective.
The first thing to understand is that the bad guys won't really be impacted. The head the The American Anti-Corruption Institute, L. Burke Files, explains to the Financial Times why restricting cash is pointless and misguided.
Peter Sands...has claimed that removal of high-denomination bank notes will deter crime. This is nonsense. After more than 25 years of investigating fraudsters and now corrupt persons in more than 90 countries, I can tell you that only in the extreme minority of cases was cash ever used — even in corruption cases. A vast majority of the funds moved involved bank wires, or the purchase and sale of valuable items such as art, antiquities, vessels or jewellery. ...Removal of high denomination bank notes is a fruitless gesture akin to curing the common cold by forbidding use of the term “cold”.
In other words, our statist friends are being disingenuous. They're trying to exploit the populace's desire for crime fighting as a means of achieving a policy that actually is designed for other purposes.
The good news, is that they still have a long way to go before achieving their goals. Notwithstanding agitation to get rid of "Benjamins" in the United States, that doesn't appear to be an immediate threat. Additionally, according to SwissInfo, is that the Swiss government has little interest in getting rid of the CHF1,000 note.
The European police agency Europol, EU finance ministers and now the European Central Bank, have recently made noises about pulling the €500 note, which has been described as the “currency of choice” for criminals. ...But Switzerland has no plans to follow suit. “The CHF1,000 note remains a useful tool for payment transactions and for storing value,” Swiss National Bank spokesman Walter Meier told swissinfo.ch.
This resistance is good news, and not just because we want to control rapacious government in North America and Europe.
A column for Yahoo mentions the important value of large-denomination dollars and euros in less developed nations.
Cash also has the added benefit of providing emergency reserves for people "with unstable exchange rates, repressive governments, capital controls or a history of banking collapses," as the Financial Times noted.
Amen. Indeed, this is one of the reasons why I like bitcoin. People need options to protect themselves from the consequences of bad government policy, regardless of where they live.
By the way, if you'll allow me a slight diversion, Bill Poole of the University of Delaware (and also a Cato Fellow) adds a very important point in a Wall Street Journal column. He warns that a fixation on monetary policy is misguided, not only because we don't want reckless easy-money policy, but also because we don't want our attention diverted from the reforms that actually could boost economic performance.
Negative central-bank interest rates will not create growth any more than the Federal Reserve’s near-zero interest rates did in the U.S. And it will divert attention from the structural problems that have plagued growth here, as well as in Europe and Japan, and how these problems can be solved. ...Where central banks can help is by identifying the structural impediments to growth and recommending a way forward. ...It is terribly important that advocates of limited government understand what is at stake. ...calls for a return to near-zero or even negative interest rates...will do little in the short run to boost growth, but it will dig the federal government into a deeper fiscal hole, further damaging long-run prospects. It needs to be repeated: Monetary policy today has little to offer to raise growth in the developed world.
Let's close by returning to the core issue of whether it is wise to allow government the sweeping powers that would accompany the elimination of physical currency.
Here are excerpts from four superb articles on the topic.
First, writing for The American Thinker, Mike Konrad argues that eliminating cash will empower government and reduce liberty.
Governments will rise to the occasion and soon will be making cash illegal. People will be forced to put their money in banks or the market, thus rescuing the central governments and the central banks that are incestuously intertwined with them. ...cash is probably the last arena of personal autonomy left. ...It has power that the government cannot control; and that is why it has to go. Of course, governments will not tell us the real reasons. ...We will be told it is for our own "good," however one defines that. ...What won't be reported will be that hacking will shoot up. Bank fraud will skyrocket. ...Going cashless may ironically streamline drug smuggling since suitcases of money weigh too much. ...The real purpose of a cashless society will be total control: Absolute Total Control. The real victims will be the public who will be forced to put all their wealth in a centralized system backed up by the good faith and credit of their respective governments. Their life savings will be eaten away yearly with negative rates. ...The end result will be the loss of all autonomy. This will be the darkest of all tyrannies. From cradle to grave one will not only be tracked in location, but on purchases. Liberty will be non-existent. However, it will be sold to us as expedient simplicity itself, freeing us from crime: Fascism with a friendly face.
Second, the invaluable Allister Heath of the U.K.-based Telegraph warns that the desire for Keynesian monetary policy is creating a slippery slope that eventually will give governments an excuse to try to completely banish cash.
...the fact that interest rates of -0.5pc or so are manageable doesn’t mean that interest rates of -4pc would be. At some point, the cost of holding cash in a bank account would become prohibitive: savers would eventually rediscover the virtues of stuffed mattresses (or buying equities, or housing, or anything with less of a negative rate). The problem is that this will embolden those officials who wish to abolish cash altogether, and switch entirely to electronic and digital money. If savers were forced to keep their money in the bank, the argument goes, then they would be forced to put up with even huge negative rates. ...But abolishing cash wouldn’t actually work, and would come with terrible side-effects. For a start, people would begin to treat highly negative interest rates as a form of confiscatory taxation: they would be very angry indeed, especially if rates were significantly more negative than inflation. ...Criminals who wished to evade tax or engage in illegal activities would still be able to bypass the system: they would start using foreign currencies, precious metals or other commodities as a means of exchange and store of value... The last thing we now need is harebrained schemes to abolish cash. It wouldn’t work, and the public rightly wouldn’t tolerate it.
The Wall Street Journal has opined on the issue as well.
...we shouldn’t be surprised that politicians and central bankers are now waging a war on cash. That’s right, policy makers in Europe and the U.S. want to make it harder for the hoi polloi to hold actual currency. ...the European Central Bank would like to ban €500 notes. ...Limits on cash transactions have been spreading in Europe... Italy has made it illegal to pay cash for anything worth more than €1,000 ($1,116), while France cut its limit to €1,000 from €3,000 last year. British merchants accepting more than €15,000 in cash per transaction must first register with the tax authorities. ...Germany’s Deputy Finance Minister Michael Meister recently proposed a €5,000 cap on cash transactions. ...The enemies of cash claim that only crooks and cranks need large-denomination bills. They want large transactions to be made electronically so government can follow them. Yet...Criminals will find a way, large bills or not. The real reason the war on cash is gearing up now is political: Politicians and central bankers fear that holders of currency could undermine their brave new monetary world of negative interest rates. ...Negative rates are a tax on deposits with banks, with the goal of prodding depositors to remove their cash and spend it... But that goal will be undermined if citizens hoard cash. ...So, presto, ban cash. ...If the benighted peasants won’t spend on their own, well, make it that much harder for them to save money even in their own mattresses. All of which ignores the virtues of cash for law-abiding citizens. Cash allows legitimate transactions to be executed quickly, without either party paying fees to a bank or credit-card processor. Cash also lets millions of low-income people participate in the economy without maintaining a bank account, the costs of which are mounting as post-2008 regulations drop the ax on fee-free retail banking. While there’s always a risk of being mugged on the way to the store, digital transactions are subject to hacking and computer theft. ...the reason gray markets exist is because high taxes and regulatory costs drive otherwise honest businesses off the books. Politicians may want to think twice about cracking down on the cash economy in a way that might destroy businesses and add millions to the jobless rolls. ...it’s hard to avoid the conclusion that the politicians want to bar cash as one more infringement on economic liberty. They may go after the big bills now, but does anyone think they’d stop there? ...Beware politicians trying to limit the ways you can conduct private economic business. It never turns out well.
Last, but not least, Glenn Reynolds, a law professor at the University of Tennessee, explores the downsides of banning cash in a column for USA Today.
...we need to restore the $500 and $1000 bills. And the reason is that people like Larry Summers have done a horrible job. ...What is a $100 bill worth now, compared to 1969? According to the U.S. Inflation Calculator online, a $100 bill today has the equivalent purchasing power of $15.49 in 1969 dollars. ...And although inflation isn’t running very high at the moment, this trend will only continue. If the next few decades are like the last few, paper money in current denominations will become basically useless. ...to our ruling class this isn’t a bug, but a feature. Governments want to get rid of cash... But at a time when, almost no matter where you look in the world, the parts of it controlled by the experts and technocrats (like Larry Summers) seem to be doing badly, it seems reasonable to ask: Why give them still more control over the economy? What reason is there to think that they’ll use that control fairly, or even competently? Their track record isn’t very impressive. Cash has a lot of virtues. One of them is that it allows people to engage in voluntary transactions without the knowledge or permission of anyone else. Governments call this suspicious, but the rest of us call it something else: Freedom.
Amen. Glenn nails it.
Banning cash is a scheme concocted by politicians and bureaucrats who already have demonstrated that they are incapable of competently administering the bloated public sector that already exists.
The idea that they should be given added power to extract more of our money and manipulate our spending is absurd. Laughably absurd if you read Mark Steyn.
P.S. I actually wouldn't mind getting rid of the government's physical currency, but only if the result was a system that actually enhanced liberty and prosperity. Unfortunately, I don't expect that to happen in the near future.
There's an ongoing debate about Keynesian economics, stimulus spending, and various versions of fiscal austerity, and regular readers know I do everything possible to explain that you can promote added prosperity by reducing the burden of government spending.
Simply stated, we get more jobs, output, and growth when resources are allocated by competitive markets. But when resources are allocated by political forces, cronyism and pork cause inefficiency and waste.
That's why statist nations languish and market-oriented countries flourish.
Paul Krugman has a different perspective on these issues, which is hardly a revelation. But I am surprised that he often times doesn't get the numbers quite right when he delves into specific case studies.
He claimed that spending cuts caused an Estonian economic downturn in 2008, but the government's budget actually skyrocketed by 18 percent that year.
He complained about a "government pullback" in the United Kingdom even though the data show that government spending was climbing faster than inflation.
He even claimed that Hollande's election in France was a revolt against austerity, notwithstanding the fact that the burden of government spending rose during the Sarkozy years.
My colleague Alan Reynolds pointed out that Krugman mischaracterized the supposed austerity in the PIIGS nations such as Portugal, Ireland, Italy, Greece, and Spain.
We have another example to add to the list.
He now wants us to believe that Germany has been a good Keynesian nation.
Here's some of what Professor Krugman wrote for the New York Times.
I hear people trying to dismiss the overwhelming evidence for large economic damage from fiscal austerity by pointing to Germany: “You say that austerity hurts growth, but the Germans have done a lot of austerity and they’re booming.” Public service announcement: Never, ever make claims about a country’s economic policies (or actually anything about economics) on the basis of what you think you’ve heard people say. Yes, you often hear people talking about austerity, and the Germans are big on praising and demanding austerity. But have they actually imposed a lot of it on themselves? Not so much.
In some sense, I agree with Krugman. I don't think the Germans have imposed much austerity.
But here's the problem with his article. We know from the examples above that he's complained about supposed austerity in places such as the United Kingdom and France, so one would think that the German government must have been more profligate with the public purse.
After all, Krugman wrote they haven't "imposed a lot of [austerity] on themselves."
So I followed the advice in Krugman's "public service announcement." I didn't just repeat what people have said. I dug into the data to see what happened to government spending in various nations.
And I know you'll be shocked to see that Krugman was wrong. The Germans have been more frugal (at least in the sense of increasing spending at the slowest rate) than nations that supposedly are guilty of "spending cuts."
To ensure that I'm not guilty of cherry-picking the data, I look at three different base years. But it doesn't matter whether we start before, during, or after the recession. Germany increased spending at the slowest rate.
Moreover, if you look at the IMF data, you'll see that the Germans also were more frugal than the Swedes, the Belgium, the Dutch, and the Austrians.
So I'm not sure what Krugman is trying to tell us with his chart.
By the way, spending in Switzerland grew at roughly the same rate as it did in Germany. So if Professor Krugman is highlighting Germany as a role model, maybe we can take that as an indirect endorsement of Switzerland's very good spending cap?
But I won't hold my breath waiting for that endorsement to become official. After all, Switzerland has reduced the burden of government spending thanks to the spending cap.
Not exactly in line with Krugman's ideological agenda.
P.S. This isn't the first time I've had to deal with folks who mischaracterize German fiscal policy. When Professor Epstein and I debated a couple of Keynesians in NYC as part of the Intelligence Squared debate, one of our opponents asserted that Germany was a case study for Keynesian stimulus. But when I looked at the data, it turned out that he was prevaricating.
P.P.S. This post, I hasten to add, is not an endorsement of German fiscal policy. As I explained while correcting a mistake in the Washington Post, the burden of government is far too large in Germany. The only good thing I can say is that it hasn't grown that rapidly in recent years.
P.P.P.S. Let's close with a look at another example of Krugman's misleading work. He recently implied that an economist from the Heritage Foundation was being dishonest in some austerity testimony, but I dug into the numbers and discovered that, "critics of Heritage are relying largely on speculative data about what politicians might (or might not) do in the future to imply that the Heritage economist was wrong in his presentation of what’s actually happened over the past six years"
Responding to a student question after a recent Kansas State debate with Brad DeLong I posed a conceptual puzzle. I asked students to ponder why textbooks treat Treasury sales of government bonds as a “stimulus” to demand (nominal GDP) in the same sense as Federal Reserve purchases of such bonds. “Those are very different polices,” I noted; “Why should they have the same effect?”
The remark was intended to encourage students to probe more deeply into what such metaphors as “stimulating” or “jump starting” really mean, not to accept as dogma that fiscal and monetary policy are equally effective or that economists are certain just how they work.
DeLong’s misinterpretation of my question led him to lecture me that, “if you really do think that monetary expansion undoes fiscal expansion because monetary expansion buys bonds and fiscal expansion sells bonds, you need to educate yourself.” Citing that wholly imaginary rewriting of my question, Paul Krugman wrote, “My heart goes out to Brad DeLong, who debated Alan Reynolds and discovered that his opponent really doesn’t understand at all how either fiscal or monetary policy work.”
Did I really say that “monetary expansion undoes fiscal expansion”? Of course not. If that had been my question, I would have answered myself by saying that piling more debt on the backs of taxpayers is unlikely to stimulate private spending (much less encourage more or better labor and capital) unless the added debt is “monetized” by the Fed and regulators allow banks to lend more to private borrowers. DeLong made much the same point by saying, “Expansionary monetary policy makes it a sure thing that expansionary fiscal policy is effective by removing the channels for interest-rate and tax crowding out.”
The Fed’s current bond-buying spree is bound to have some effect, if only to facilitate cheap corporate buybacks of shares and speculative day trading of such stocks on margin. But selling more government bonds per se (if the Fed won’t buy more) would be just as much an added burden for taxpayers as it would be a benefit to whoever receives the resulting government transfers, contracts or subsidies.
This make-believe squabble about monetary expansion undoing fiscal expansion exists only in DeLong’s imagination, like my non-prediction of mammoth inflation or Krugman’s non-facts about Ireland’s fiscal frugality.
I do have a few minor issues, however, with DeLong’s remark that, “It's not possible to get confused if you have the IS-LM diagram in front of you.” To lean too heavily on John Hicks’ 1937 ad hoc diagram, which reduced the whole economy to two curves manipulated separately, is not an answer but rather part of my question. As theory goes, I much prefer Hicks’ 1975 book, The Crisis in Keynesian Economics (57) including his assessment (57) that “one of the worst things about Keynes’s doctrine . . . is the impression he gives that Liquidity Preference is wholly, and always, bad. . . .The trouble lies deep in his version of short-run macroeconomics, in which one form of investment appears as good as another.”
The question I posed to the Kansas students was more clearly explained in my 2009 Cato Journal essay, “The Misuse of Economic History.” I wrote that “it is a non sequitur to claim a ‘liquidity trap’ demonstrates that aggressive fiscal policy will ‘raise aggregate spending.’ Fiscal stimulus means selling more government securities; monetary stimulus mainly means central banks buying such securities with new money. Those are distinctly different policies, and their effectiveness raises distinctly different questions. Do big budget deficits stimulate demand? In postwar U.S. data there is no discernible connection, over short periods or long, between cyclically adjusted budget deficits and the growth of final sales to domestic purchasers. It is easier to find connections between aggregate spending and exogenous monetary policy changes.”
These are questions of fact, not theory. I was using historical data to show that monetary policy appeared relatively potent at times when Krugman claims it was not, while fiscal policy in the demand-side sense (budget deficits rather than tax rates) had no clear links to nominal or real GDP even during the Great Depression or post-1991 Japan.
Although Keynesian theory postulates a solid link between cyclically-adjusted budget deficits and changes in aggregate demand (nominal GDP), I find no such correlation in any data at home or abroad. Counterfactual simulations from Keynesian black box models are not evidence.
The burden of proof is entirely on those who assert that some measure of fiscal stimulus is linked with some measure of aggregate demand. Where did that happen and when? I am almost begging for some shred of evidence. In End This Depression Now! (234) Krugman could only uncover a study of military spending which suggests, he says, that “every year in which there was big [military] spending increase was also a year of strong growth.” Even if that causality was not ambiguous (i.e., we could afford a fatter defense budget when the economy and revenues were strong) any effect of military contracts on (defense industry) output says nothing about deficits per se, nor about the bulk of federal spending which is on payrolls, subsidies and transfers.
DeLong believes “anything that boosts the government's deficit over the next two years passes the benefit-cost test--anything at all.” Just as there is no obvious reason to expect identical economic effects from marketing or monetizing federal debt, however, there is likewise no reason to expect all types of government spending (purchases, payrolls, interest expense and transfers) to have the same effect. The evidence that different sorts of taxing and spending have quite different effects (to get back to my initial microeconomic question) is entirely on the side of Casey Mulligan, who found increased transfer payments positively harmful to employment and output.
Unless government debt was literally a free lunch, how could it possibly be true that “anything that boosts the government's deficit over the next two years passes the benefit-cost test”? Suppose interest rates doubled or tripled, as consequence of faster growth of nominal GDP, that would greatly increases the government’s deficit through larger interest payments. Would the “benefit” of that larger deficit really exceed the added interest cost to taxpayers? Would it qualify as a stimulus?
In the Brookings Papers on Economic Activity Brad DeLong and Larry Summers remind us of the changing fashions defining the mainstream economic consensus: “The late 1960s and 1970s,” they write, “provided powerful demonstrations that monetary policy had major effects on economic performance. The 1970s provided convincing evidence . . . that in the medium and long runs demand-management policy [whether fiscal or monetary] could affect levels of nominal but not real income. The late 1970s and the 1980s brought increased emphasis on the supply-side aspects of tax and expenditure policies. These three factors had led most economists by the 1990s to reject discretionary fiscal policy directed at aggregate demand as a tool of stabilization policy. Indeed, a central element of the economic strategy of the Clinton administration was the idea that deficit-reduction policy was likely to accelerate economic growth.”
For the DeLong and Summers to switch from advocating deficit-reduction in the Clinton-Bush years to advocating deficit-expansion in 2012 demonstrates impressive intellectual agility. Yet actual results of larger spending and debt have been far less impressive than the results of U.S. and Canadian spending reduction from 1992 to 2000.
For me to continue to “reject discretionary fiscal policy as a tool of stabilization policy,” just as “most economists” (including DeLong and Summers) did a decade ago, is now being redefined as ignorant heresy by DeLong and Krugman, who both wrote of being terrified by modest budget deficits in 2003-2004. The new reality, as opposed to old theory, is that national, historical and international evidence that increased government spending, borrowing and taxing is commonly unproductive or counterproductive has only grown stronger in recent years. Compare, for example, Ireland and Iceland.
President Bush imposed a so-called stimulus plan in 2008 and President Obama imposed an even bigger "stimulus" in 2009. Based upon the economy's performance over the past five-plus years, those plans didn't work.
Japan has spent the past 20-plus years imposing one Keynesian scheme after another, and the net effect is economic stagnation and record debt.
Going back further in time, Presidents Hoover and Roosevelt dramatically increased the burden of government spending, mostly financed with borrowing, and a recession became a Great Depression.
That's not exactly a successful track record, but Paul Krugman thinks the evidence is on his side and that it's time to declare victory for Keynesian economics.
Those of us who have spent years arguing against premature fiscal austerity have just had a good two weeks. Academic studies that supposedly justified austerity have lost credibility; hard-liners in the European Commission and elsewhere have softened their rhetoric. The tone of the conversation has definitely changed.
But Krugman doesn't just want to declare victory. He also spikes the football and does a dance in the end zone.
I’m always right while the people who disagree with me are always wrong. And not just wrong, they’re often knaves or fools. ...look at the results: again and again, people on the opposite side prove to have used bad logic, bad data, the wrong historical analogies, or all of the above. I’m Krugtron the Invincible!
So why does Krugman feel so confident about his position, notwithstanding the evidence? Veronique de Rugy has a concise and fair assessment of the Keynesian rationale. Simply stated, no matter how bad the results, the Keynesians think the economy would have been in even worse shape in the absence of supposed stimulus.
...the country’s economic performance of the last four or five years can hardly be described has a rousing success for Keynesian economics, at least as implemented by the administration. In fact, measured by the unemployment rate, it hasn’t been a success by the administration’s own standards. To that, Krugman says that the stimulus implemented by the administration wasn’t big enough and, as such, that Keynesian economics hasn’t been tried yet.
Veronique, by the way, points out why this argument is utterly unpersuasive by using the same logic to declare victory for markets.
But by this logic, free-market economics is doing pretty well, too: I think we can all agree that free-market economics wasn’t tried. The economy hasn’t really recovered properly. This must mean free-market economics has won.
But I think the best part of Veronique's article is the section explaining that not all austerity is created equal. Simply stated, why expect better economic performance if "austerity" means that taxes go up and the burden of government spending stays the same?
Here's some of what Veronique wrote on this issue.
...austerity, as defined by economists, represents the measures implemented by a government in order to reduce the debt-to-GDP ratio. Unlike Keynesians, I do not think that debt is good for economic growth, but I would prefer the word “austerity” to describe the measures implemented to shrink the size and scope of government... In other words, the important question about austerity has less to do with the size of the austerity package than what type of austerity measures are implemented. ...when governments try to reduce the debt by raising taxes, it is likely to result in deep and pronounced recessions, possibly making the fiscal adjustment counterproductive. ...austerity measures implemented in Europe are not the kind of austerity we actually need. In fact, the data shows that it has mostly consisted in raising taxes.
Since I've repeatedly made these same points, you can understand why I'm a big fan of her analysis.
Moreover, I think this gives us some insight into why Krugman may actually think he has prevailed. Simply stated, he's comparing Keynesianism to the IMF/European version of austerity.
But that type of "austerity" - as you can see from one of Veronique's charts - is overwhelmingly comprised of tax hikes.
Yet is anybody surprised that we haven't seen much - if any - growth in tax-happy nations such as Greece, Portugal, Italy, Ireland, Spain, and the United Kingdom?
What we really need are examples of nations that have reduced the burden of government spending. Then we can compare those results with nations that have tried Keynesianism and nations that have tried tax increases.
Sadly, we only have a few examples of this smaller-government approach. But we get very positive results.
The burden of government spending was reduced during the Reagan years and Clinton years, for instance, and the economy enjoyed good growth in both periods.
Canada was even more aggressive about reducing the size of the state during the 1990s. Their economy also did quite well, notwithstanding Keynesian dogma.
I suspect Keynesians would respond to these examples by asserting it's okay - at least in theory - to restrain spending if the economy isn't in recession.*
But then how do they respond to the experience of the Baltic nations? When the financial crisis hit a few years ago, those governments imposed genuine spending cuts and largely avoided the big tax hikes that have plagued other European nations.
Now Estonia, Lithuania, and Latvia are enjoying impressive growth while the nations that raised taxes seem stuck in perpetual recession.**
So let's recap. When nations try Keynesianism, they get bad results because more government spending isn't conducive to growth.
When nations raise taxes, they get bad results because you don't get more growth by penalizing work, saving, investment, and entrepreneurship.
But when nations reduce the burden of government spending and leave more resources in the productive sector, the economy recovers.
Seems like one side can declare victory and spike the football, but it's not Paul Krugman and the Keynesians.
*I'm guessing one would be hard pressed to find any examples of modern-day Keynesians ever supporting fiscal restraint.
**Krugman tried to undermine the Baltic model of fiscal restraint by attacking Estonia, but wound up with egg on his face.
With the death of Margaret Thatcher, and the ensuing profusion of commentary on her legacy, it is worth looking back at an overlooked chapter in the Thatcher story. I am referring to her 1981 showdown with the Keynesian establishment—a showdown that the Iron Lady won handily. Before getting caught up with the phony “austerity vs. fiscal stimulus” debate, the chattering classes should take note of how Mrs. Thatcher debunked the Keynesian “fiscal factoid.”
According to the Oxford English Dictionary, a factoid is “an item of unreliable information that is reported and repeated so often that it becomes accepted as fact.” The standard Keynesian fiscal policy prescription for the maintenance of non-inflationary full employment is a fiscal factoid. The chattering classes can repeat this factoid on cue: to stimulate the economy, expand the government’s deficit (or shrink its surplus); and to rein in an overheated economy, shrink the government’s deficit (or expand its surplus).
Even the economic oracles embrace the fiscal factoid. That, of course, is one reason that the Keynesians’ fiscal mantra has become a factoid. No less than Nobelist Paul Krugman repeats it ad nauseam. Now, the new secretary of the treasury, Jack Lew (who claims no economic expertise), is in Europe peddling the fiscal factoid.
Unfortunately, the grim reaper finally caught up with Margaret Thatcher—but not before she laid waste to 364 wrong-headed British Keynesians.
In 1981, Prime Minister Thatcher made a dash for confidence and growth via a fiscal squeeze. To restart the economy, Mrs. Thatcher instituted a fierce attack on the British fiscal deficit, coupled with an expansionary monetary policy. Her moves were immediately condemned by 364 distinguished economists. In a letter to The Times, they wrote a knee-jerk Keynesian response: “Present policies will deepen the depression, erode the industrial base of our economy and threaten its social and political stability.”
Mrs. Thatcher was quickly vindicated. No sooner had the 364 affixed their signatures to that letter than the economy boomed. Confidence in the British economy was restored, and Mrs. Thatcher was able to introduce a long series of deep, free-market reforms.
As for the 364 economists (who included seventy-six present or past professors, a majority of the Chief Economic Advisors to the Government in the post-WWII period, and the president, as well as nine present or past vice-presidents, and the secretary general of the Royal Economic Society), they were not only wrong, but also came to look ridiculous.
In the United States, the peddlers of the fiscal factoid have never suffered the intellectual humiliation of their British counterparts. In consequence, American Keynesians can continue to peddle snake oil with reckless abandon and continue to influence policy in Washington, D.C., and elsewhere.