Topic: Finance, Banking & Monetary Policy

The Financial Times on Robert Gates

Kudos to the Financial Times (subscription may be required) for figuring out what most other journalists and editorial writers haven’t seemed to grasp concerning Robert Gates’s economy initiative at the Pentagon.

[H]is aim is not to cut the overall budget radically; it is merely to achieve savings in the military bureaucracy and thus, against a background of broader fiscal constraint, protect spending on new weapons and other outlays.  (my emphasis)

The reforms in and of themselves are “commendable,” the FT notes, but they don’t amount to very much in the grand scheme, and they therefore do not go nearly far enough. Indeed, as I and others have noted, U.S. military spending will continue to rise if Bob Gates gets his way. This isn’t good enough.

The FT editors agree:

The US needs a much more searching review of its military spending, one that aims to do more than merely curb its growth.

Anyone interested in a comprehensive proposal (three, actually) for substantially reducing U.S. military spending by revisiting the roles, responsibilities, and missions that are currently assigned to Gates’s department can find it here.

When Keynesians Attack, Part II

I’m still dealing with the statist echo chamber, having been hit with two additional attacks for the supposed sin of endorsing Reaganomics over Obamanomics (my responses to the other attacks can be found here and here). Some guy at the Atlantic Monthly named Steve Benen issued a critique focusing on the timing of the recession and recovery in Reagan’s first term. He reproduces a Krugman chart (see below) and also adds his own commentary.

Reagan’s first big tax cut was signed in August 1981. Over the next year or so, unemployment went from just over 7% to just under 11%. In September 1982, Reagan raised taxes, and unemployment fell soon after. We’re all aware, of course, of the correlation/causation dynamic, but as Krugman noted in January, “[U]nemployment, which had been stable until Reagan cut taxes, soared during the 15 months that followed the tax cut; it didn’t start falling until Reagan backtracked and raised taxes.”

This argument is absurd since the recession in the early 1980s was largely the inevitable result of the Federal Reserve’s misguided monetary policy. And I would be stunned if this view wasn’t shared by 90 percent-plus of economists. So it is rather silly to say the recession was caused by tax cuts and the recovery was triggered by tax increases.

But even if we magically assume monetary policy was perfect, Benen’s argument is wrong. I don’t want to repeat myself, so I’ll just call attention to my previous blog post which explained that it is critically important to look at when tax cuts (and increases) are implemented, not when they are enacted. The data is hardly exact, because I haven’t seen good research on the annual impact of bracket creep, but there was not much net tax relief during Reagan’s first couple of years because the tax cuts were phased in over several years and other taxes were going up. So the recession actually began when taxes were flat (or perhaps even rising) and the recovery began when the economy was receiving a net tax cut. That being said, I’m not arguing that the Reagan tax cuts ended the recession. They probably helped, to be sure, but we should do good tax policy to improve long-run growth, not because of some misguided effort to fine-tune short-run growth.

The second attack comes from some blog called Econospeak, where my newest fan wrote:

I’m scratching my head here as I thought the standard pseudo-supply-side line was that the deficit exploded in the 1980’s because government spending exploded. OK, the truth is that the ratio of Federal spending to GDP neither increased nor decreased during this period. Real tax revenues per capita fell which is why the deficit rose but this notion that the burden of government fell is not factually based.

Those are some interesting points, and I might respond to them if I wanted to open a new conversation, but they’re not germane to what I said. In my original post (the one he was attacking), I commented on the “burden of government” rather than the “burden of government spending.” I’m a fiscal policy economist, so I’m tempted to claim that the sun rises and sets based on what’s happening to taxes and spending, but such factors are just two of the many policies that influence economic performance. And with regard to my assertion that Reagan reduced the “burden of government,” I’ll defer to the rankings put together for the Economic Freedom of the World Index. The score for the United States improved from 8.03 to 8.38 between 1980 and 1990 (my guess is that it peaked in 1988, but they only have data for every five years). The folks on the left may be unhappy about it, but it is completely accurate to say Reagan reduced the burden of government. And while we don’t yet have data for the Obama years, there’s a 99 percent likelihood that America’s score will decline.

This is not a partisan argument, by the way. The Economic Freedom of the World chart shows that America’s score improved during the Clinton years, particularly his second term. And the data also shows that the U.S. score dropped during the Bush years. This is why I wrote a column back in 2007 advocating Clintonomics over Bushonomics. Partisan affiliation is not what matters. If we want more prosperity, the key is shrinking the burden of government.

Last but not least, I try to make these arguments to the folks watching MSNBC.

What Part of “Nonrepresentative” Don’t Profit-Haters Get?

For the last few days, for-profit colleges and universities have been suffering an even worse hammering than usual, both in the media and their pocketbooks. The proximate cause: a GAO report released Wednesday that has been portrayed as revealing “systemic” and “pervasive” fraud — and otherwise just seamy behavior — by the for-profit sector.

No doubt there is some bad stuff going on in proprietary postsecondary education. But the assault on for-profits reeks of political bullying of the unpopular kid — the kid who’s just different — as well as the never-ending Washington demonization of anyone who honestly pursues a profit. The waving of the bloody GAO report is case-in-point, and one need look no further than the following statement contained on the report’s very first page:

Results of the undercover tests and tuition comparisons cannot be projected to all for-profit colleges.

You mean, GAO investigators went to 15 non-randomly selected schools in six states and Washington, DC, and the results cannot be construed to be representative of the whole sector? And the GAO also, apparently, meant it when it wrote on page two of the report that “we investigated a nonrepresentative selection” of schools? But, then, how could Tom Harkin (D-IA), chair of the Senate Health, Education, Labor and Pensions Committee, have stated in a show-trial hearing that “GAO’s findings make it disturbingly clear that abuses in for-profit recruiting are not limited to a few rogue recruiters or even a few schools with lax oversight”?

Oh, right: Truth doesn’t matter to Harkin — only scoring political points. That not only explains how Harkin could say such a thing, but why he has targeted for-profits rather than seeking truth and purity in all sectors of higher education, including the coolest of the cool kids, public colleges. With dismal program completion rates of their own, and their imposition of huge burdens on taxpayers, you’d think they’d be worth some investigating, too.

I encourage you to read the GAO report, and you’ll see that it in no way supports a blanket condemnation of for-profit higher ed. And it’s not just because its findings can in no reasonable way be extrapolated to the whole of proprietary schooling. It’s also because many of the supposedly terrible things it discovers, while perhaps distasteful, are hardly abhorent, such as telling prospective students that they ”can” — not “will” — earn a lot of money in a profession even if that amount is well above the average. And then there’s the report’s worthless comparisons of tuition at for-profit and nearby public instituions. Once again: public colleges are heavily subsidized by taxpayers, so of course their tuition is lower. And these comparisons were also not randomly selected.

After you’ve read the GAO report, you should take in a new paper from the Center for College Affordability and Productivity, For-Profit Higher Education: Growth, Innovation and Regulation. It might be a bit too fond of the for-profit sector, which like all of higher education lives far too much off the sweat of taxpayers, but it furnishes lots of terrific data and insights about proprietary higher ed to balance out the ongoing truth-eschewing assaults the sector keeps on suffering.  

When Keynesians Attack

If I was organized enough to send Christmas cards, I would take Richard Rahn off my list. I do one blog post to call attention to his Washington Times column and it seems like everybody in the world wants to jump down my throat. I already dismissed Paul Krugman’s rant and responded to Ezra Klein’s reasonable criticism. Now it’s time to address Derek Thompson’s critique on the Atlantic’s site.

At the risk of re-stating someone else’s argument, Thompson’s central theme seems to be that there are many factors that determine economic performance and that it is unwise to make bold pronouncements about Policy A causing Result B. If that’s what Thompson is saying, I very much agree (and if it’s not what he’s trying to say, then I apologize, though I still agree with the sentiment). That’s why I referred to Reagan decreasing the burden of government and Obama increasing the burden of government — I wanted to capture all the policy changes that were taking place, including taxation, spending, monetary policy, regulation, etc. Yes, the flagship policies (tax reduction for Reagan and so-called stimulus for Obama) were important, but other factors obviously are part of the equation.

The biggest caveat, however, is that one should always be reluctant to make sweeping claims about what caused the economy to do X or Y in a given year. Economists are terrible forecasters, and we’re not even very proficient when it comes to hindsight analysis about short-run economic fluctuations. Indeed, the one part of my original post that causes me a bit of regret is that I took the lazy route and inserted an image of the chart from Richard’s column. Excerpting some of his analysis would have been a better approach, particularly since I much prefer to focus on the impact of policies on long-run growth and competitiveness (which is what I did in my New York Post column from earlier this week  and also why I’m reluctant to embrace Art Laffer’s warning of major economic problems in 2011).

But a blog post is no fun if you just indicate where you and a critic have common ground, so let me identify four disagreements that I have with Thompson’s post:

(1) To reinforce his warning about making excessive claims about different recessions/recoveries, Thompson pointed out that someone could claim that Reagan’s recovery was associated with the 1982 TEFRA tax hike. I’ve actually run across people who think this is a legitimate argument, so it’s worth taking a moment to explain why it isn’t true.

When analyzing the impact of tax policy changes, it’s important to look at when tax changes were implemented, not when they were enacted (data on annual tax rates available here). Reagan’s Economic Recovery Tax Act was enacted in 1981, but the lower tax rates weren’t fully implemented until 1984. This makes it a bit of a challenge to pinpoint when the economy actually received a net tax cut. The tax burden may have actually increased in 1981, since the parts of the Reagan tax cuts that took effect that year were offset by the impact of bracket creep (the tax code was not indexed to protect against inflation until the mid-1980s). There was a bigger tax rate reduction in 1982, but there was still bracket creep, as well as previously-legislated payroll tax increases (enacted during the Carter years). TEFRA also was enacted in 1982, which largely focused on undoing some of the business tax relief in Reagan’s 1981 plan. People have argued whether the repeal of promised tax relief is the same as a tax increase, but that’s not terribly important for this analysis. What does matter is that the tax burden did not fall much (if at all) in Reagan’s first year and might not have changed too much in 1982.

In 1983, by contrast, it’s fairly safe to say the next stage of tax rate reductions was substantially larger than any concomitant tax increases. That doesn’t mean, of course, that one should attribute all changes in growth to what’s happening to the tax code. But it does suggest that it is a bit misleading to talk about tax cuts in 1981 and tax increases in 1983.

One final point: The main insight of supply-side economics is that changes in the overall tax burden are not as important as changes in the tax structure. As such, it’s also important to look at which taxes were going up and which ones were decreasing. This is why Reagan’s 1981 tax plan compares so favorably with Bush’s 2001 tax plan (which was filled with tax credits and other policies that had little or no impact on incentives for productive behavior).

(2) In addition to wondering whether one could argue that higher taxes triggered the Reagan boom, Thompson also speculates whether it might be possible to blame the tax cuts in Obama’s stimulus for the economy’s subsequent sub-par performance. There are two problems with that hypothesis. First, a substantial share of the tax cuts in the so-called stimulus were actually new spending being laundered through the tax code (see footnote 3 of this Joint Committee on Taxation publication). To the extent that the provisions represented real tax relief, they were much more akin to Bush’s non–supply side 2001 tax cuts and a far cry from the marginal tax-rate reductions enacted in 1981 and 2003. And since even big tax cuts have little or no impact on the economy if incentives to engage in productive behavior are unaffected, there is no reason to blame (or credit) Obama’s tax provisions for anything.

(3) Why doesn’t anyone care that the Federal Reserve almost always is responsible for serious recessions? This isn’t a critique of Thompson’s post since he doesn’t address monetary policy from this angle, but if we go down the list of serious economic hiccups in recent history (1974-75, 1980-82, and 2008-09), bad monetary policy inevitably is a major cause. In short, the Fed periodically engages in easy-money policy. This causes malinvestment and/or inflation, and a recession seems to be an unavoidable consequence. Yet the Fed seems to dodge any serious blame. At some point, one hopes that policy makers (especially Fed governors) will learn that easy-money policies such as artificially low interest rates are not a smart approach.

(4) Thompson writes, “Is Mitchell really saying that $140 billion on Medicaid, firefighters, teachers, and infrastructure projects are costing the economy five percentage points of economic growth?” No, I’m not saying that and didn’t say that, but I have been saying for quite some time that taking money out of the economy’s left pocket and putting it in the economy’s right pockets doesn’t magically increase prosperity. And to the extent money is borrowed from private capital markets and diverted to inefficient and counter-productive programs, the net impact on the economy is negative. Thompson also writes that, “Our unemployment picture is a little more complicated than ‘Oh my god, Obama is killing jobs by taking over the states’ Medicaid burden!’” Since I’m not aware of anybody who’s made that argument, I’m not sure how to respond. That being said, jobs will be killed by having Washington take over state Medicaid budgets. Such a move would lead to a net increase in the burden of government spending, and that additional spending would divert resources from the productive sector of the economy.

The moral of the story, though, is to let Richard Rahn publicize his own work.


I was listening to NPR in the car yesterday, when a report came on about the implications of deflation — which apparently is the latest concern regarding financial markets. The report nearly made me fall out of my seat from bewilderment and frustration.

Adam Davidson, the NPR reporter, waxed eloquent about how deflation turns normal economic and investment calculus on its head.  But his explanation was so poor that he ended up saying exactly the opposite of what he should have said.

Here’s how it went for me:

Davidson: “Ladies and gentlemen, I have an amazing investment opportunity for you. Give me $100, just a hundred, and in one year I promise it will be worth 93 bucks. We call it the deflation special.”

My reaction: No, sir! Under deflation, $100 today would increase in value to $107 (assuming your implicit rate of deflation).  Help! Stop the car! …Wait, I’m the one driving…what just happened?

Davidson: “All right, seriously, nobody is giving anybody a hundred bucks just so they can lose seven.”

My reaction: No, no, please, please take my money! I’d give you a million dollars if I had that amount. I really would!

Davidson: “That’s the opposite of an investment opportunity, which is precisely why economists and central bankers get terrified when they hear the word deflation.”

My reaction: Well, a small amount of deflation can be consistent with flexible prices. It’s only rapid spiraling deflation that we should worry about.  But the same is true about rapid spiraling inflation.

Davidson: “Technically, deflation means that the prices of all kinds of goods and services keep falling, rather than what they normally do, which is rise. And deflation means that not just one investment but all investments are worth less next year because the currency they are based on — like the U.S. dollar — is going to be worth less next year.”

My reaction: That word “technically” should be banned from his vocabulary.  Again, the confusion here arises from using the word “currency.” Deflation means lower prices tomorrow compared to today and, therefore, a higher value of each dollar.  Indeed, all debts appreciate in value in a deflationary environment.

Davidson: “Why pay money to build a new factory or buy a house or hire an employee or go to school if the payoff will be worth (less) than the money you put in?”

My reaction: Lenders would be happy to lend money for investment projects because deflation implies a higher rate of return on them. It’s the borrowers and entrepreneurs who would not want to borrow funds because deflation escalates the real value of debtors’ liabilities.

Davidson: “Deflation, once it starts, is extremely hard to stop. Which is why the Federal Reserve is doing everything it can to prevent it.  Although, all the tools used to prevent deflation, like increasing the money supply and keeping interest rates incredibly low, can cause another problem: inflation.”

My reaction: What is it that you want, man? Make up your mind!

Davidson: “Now, central bankers tend to think that they can stop inflation more easily than deflation. So given the choice, they’ll inflate.”

My reaction: Those horrible Fed officials! I always suspected they were up to no good — always ginning up inflation. Now I know why!

I wonder which economics school Davidson (and his editor) attended. My guess: none. Let’s see … what’s on the next radio channel?

Even Keynesian Accounting Can’t Find All That ‘Stimulus’

From January 2009 to the present, President Obama and his team have repeatedly made grandiose claims about the economic benefits of shoveling money at shovel-ready projects or green jobs.  “It is largely thanks to the Recovery Act that a second Depression is no longer a possibility,” said the President.   He also claimed that lavish spending alone (not Federal Reserve actions or bank bailouts) is what prevented the unemployment rate from “getting up to … 15%.”

If any of that were remotely close to being true then, as a matter of simple accounting, rising federal spending would have shown up as a huge offset to falling GDP in 2009, and also as a major component of the modest increase in GDP growth in early 2010.   On the contrary, the table below shows that the increase in federal nondefense spending contributed only two-tenths of one percent (0.2) to the change in GDP in 2009.  That was no better than 2008 when the Recovery Act did not exist.  If nondefense spending had not increased at all in 2009 (unlike 2008) then GDP would have fallen 2.8% rather than 2.6% — scarcely the difference between a recession and a “second Depression.”  If nondefense federal spending had not increased at all in 2010, the economy still would have grown at a 3.6% pace in the first quarter, 2.1% in the second.  Cutbacks in state and local spending were a trivial damper on GDP growth last year, contrary to recent speculation, and real state and local spending rose significantly in this year’s second quarter (unlike the first).

This is just an exercise in crude Keynesian accounting, not economics.  Yet it nonetheless makes the stimulus bill look like a huge waste of money.  The reason Keynesian accounting is no substitute for economics is that governments can only spend other peoples’ money.  To claim that such spending is a net addition to “aggregate demand” is to ignore those other people — namely, current and future taxpayers.

Nobel Laureate Robert Lucas put it this way:

If the government builds a bridge … by taking tax money away from somebody else, and using that to pay the bridge builder — the guys who work on the bridge — then it’s just a wash.  It has no first-starter effect.  There’s no reason to expect any stimulation.  And, in some sense, there’s nothing to apply a multiplier to.  You apply a multiplier to the bridge builders, then you’ve got to apply the same multiplier with a minus sign to the people you taxed to build the bridge.  And then taxing them later isn’t going to help, we know that.

Are These Examples of Washington Corruption?

The “appearance of impropriety” is often considered the Washington standard for corruption and misbehavior. With that in mind, alarm bells began ringing in my head when I read this Washington Times report about Jacob Lew, Obama’s nominee to head the Office of Management and Budget. A snippet:

President Obama’s choice to be the government’s chief budget officer received a bonus of more than $900,000 from Citigroup Inc. last year — after the Wall Street firm for which he worked received a massive taxpayer bailout. The money was paid to Jacob Lew in January 2009, about two weeks before he joined the State Department as deputy secretary of state, according to a newly filed ethics form. The payout came on top of the already hefty $1.1 million Citigroup compensation package for 2008 that he reported last year. Administration officials and members of Congress last year expressed outrage that executives at other bailed-out firms, such as American International Group Inc., awarded bonuses to top executives. State Department officials at the time steadfastly refused to say if Mr. Lew received a post-bailout bonus from Citigroup in response to inquiries from The Washington Times. But Mr. Lew’s latest financial disclosure report, provided by the State Department on Wednesday, makes clear that he did receive a significant windfall. …The records show that Mr. Lew received the $944,578 payment four days after he filed his 2008 ethics disclosure.

Why did Citigroup decide to hire Lew, a career DC political operator, for $1.1 million? As a former political aide, lobbyist, lawyer, and political appointee, what particular talents did he have to justify that salary to manage an investment division? Did the presence of Lew (as well as other Washington insiders such as Robert Rubin) help Citigroup get a big bucket of money from taxpayers as part of the TARP bailout? Did Lew’s big $900K in 2009 have anything to do with the money the bank got from taxpayers? Is it a bit suspicious that he received his big windfall bonus four days after filing a financial disclosure?

See if you can draw any conclusion other than this was a typical example of the sleazy relationship of big government and big business.

Lest anyone think I’m being partisan, let’s now look at another story featuring Senator Richard Shelby. The Alabama Republican and his former aides have a nice relationship that means more campaign cash for him, lucrative fees for them, and lots of our tax dollars being diverted to such recipients as the state’s university system. Here are some of the sordid details:

Since 2008, Alabama Sen. Richard Shelby has steered more than $250 million in earmarks to beneficiaries whose lobbyists used to work in his Senate office — including millions for Alabama universities represented by a former top staffer. In a mix of revolving-door and campaign finance politics, the same organizations that have enjoyed Shelby’s earmarks have seen their lobbyists and employees contribute nearly $1 million to Shelby’s campaign and political action committee since 1999, according to federal records. …Shelby’s earmarking doesn’t appear to run afoul of Senate rules or federal ethics laws. But critics said his tactics are part of a Washington culture in which lawmakers direct money back home to narrow interests, which, in turn, hire well-connected lobbyists — often former congressional aides — who enjoy special access on Capitol Hill.

Some people think the answer to such shenanigans is more ethics laws, corruption laws, and campaign-finance laws, but that’s like putting a band-aid on a compound fracture. Besides, it is quite likely that no laws were broken, either by Lew, Citigroup, Shelby, or his former aides. This is just the way Washington works, and the beneficiaries are the insiders who know how to milk the system. The only way to actually reduce both legal and illegal corruption in Washington is to shrink the size of government. The sleaze will not go away until politicians have less ability to steer our money to special interests — whether they are Wall Street banks or Alabama universities. This video elaborates: