The Difference Between Physics and Mainstream Economics

Newspapers this morning were full of the story of how physicists at CERN in Geneva have demonstrated that a particle (sub-atomic one) could go faster than the speed of light.  I’m no physicist, (although I do make extensive use of the principles of gravity and inertia), but this appears to be a rather startling result – one of those things current accepted theory says can’t happen.  The Globe and Mail report:

 A fundamental pillar of physics – that nothing can go faster than the speed of light – appears to be smashed by an oddball subatomic particle that has apparently made a giant end run around Albert Einstein’s theories.

Scientists at the world’s largest physics lab said Thursday they have clocked neutrinos travelling faster than light. That’s something that according to Einstein’s 1905 special theory of relativity – the famous E (equals) mc2 equation – just doesn’t happen.

Mr. Gillies told The Associated Press that the readings have so astounded researchers that they are asking others to independently verify the measurements before claiming an actual discovery.

“They are inviting the broader physics community to look at what they’ve done and really scrutinize it in great detail, and ideally for someone elsewhere in the world to repeat the measurements,” he said Thursday.

Scientists at the competing Fermilab in Chicago have promised to start such work immediately.

“It’s a shock,” said Fermilab head theoretician Stephen Parke, who was not part of the research in Geneva. “It’s going to cause us problems, no doubt about that – if it’s true.”

Wow. What a difference. So when reality demonstrates something that theory says can’t happen, the physicists think it’s a problem and set out to: (a) verify the results, and (b) revise theory to account for it.  In mainstream macroeconomics as it’s been practiced since the 1970’s, they do just the opposite.  If something happens in reality that theory says or assumes can’t happen, mainstream macro-economists will just ignore facts. After all, an elegant mathematical theory is just too beautiful to abandon.  Why describe the workings of the real world when you can build models of hypothetical mathematical worlds that can never exist.   </end snarky sarcasm>

The Fed’s New “Twist” – Not Likely To Help

Late Wednesday The Federal Reserve announced a new program to try to stimulate  the economy so that maybe somebody, somewhere could get a new job, or maybe it’s so that critics would shut-up about employment.  It’s always hard to tell what The Fed’s real objectives are.  I don’t have time to explain now why it’s not likely to do much. But I didn’t want it to go unnoticed, so I’ll give you Stephanie Kelton from neweconomicperpectives, the UM Kansas City MMT people:

Ben Kenobi Launches Operation Twist: Will it Save the Republic?

The Federal Open Market Committee (FOMC) just announced that it’s going to begin another round of asset buying, this time offsetting its purchases of longer-dated securities with sales of shorter term holdings. The goal? Flatten the yield curve. The hope? Engineer a recovery by helping homeowners refinance at lower rates and making broader financial conditions more attractive to would-be-borrowers.

At this point, it looks like Obi-Ben Kenobi realizes that Congress isn’t going to lend a hand with the recovery. Indeed, as a scholar of the Great Depression, he’s probably deeply concerned by the “Go Big” mantra that is now drawing support from people like Alice Rivlin, former Vice Chair of the Federal Reserve.  And so it is Ben, and Ben alone, who must fight to prevent the double-dip. It is as if he’s responding to the public’s desperate cry, “Help me Obi-Ben Kenobi. You’re my only hope.” Will it work?  Not a chance, but that conversation is taking place over at Pragmatic Capitalism, so drop in and find out why.  Below is a description, taken from the full FRB press release, that describes just what the Fed is going to do.  May the force be with us all.

“To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.”

John Stossel Fails an Education Test and Demonstrates That He’s Economically Illiterate

John Stossel is a Fox Business News reporter.  Stossel is an unabashed “libertarian” with a strong Austrian orientation on economics who focuses on economic issues.  He’s made a living out of being indignant and disgusted by “liberals” and “big government” which he sees as the root of all economic problems.  He’s been quite successful over the years, first at ABC News and now at Fox.   He also writes a blog to go with his Fox News show.

In other research I was doing recently I stumbled upon a post of his from Sept 15 called “Stupid in America” in which he asserts that schools have gotten too expensive and don’t deliver the goods.  In Stossel’s own words and graph:

School spending has gone through the roof and test scores are flat.

While most every other service in life has gotten faster, better, and cheaper, one of the most important things we buy — education — has remained completely stagnant, unchanged since we started measuring it in 1970.

It looks appalling right?  Scores have increased by 1% but the cost of an education appears to have increased by approximately 246% ($43,000 up to $149,000).  Except it’s very deceptive and the obvious product of an economic illiterate.  There’s two clear, elementary economic errors here.

First, he’s comparing test scores, a measure that’s in absolute terms on fixed scale to dollars spent in nominal terms over a 40 year period.  Dollars are not fixed units of measure.  They change value over time because of inflation.  If you want to compare test scores to dollars spent “buying” those test scores, then you need to use real dollars with the inflation taken out.

So let’s do that.  Using the Bureau of Labor Statistics CPI Inflation Calculator, we find that what $43,000 purchased in 1970 would require $241,660. in 2010.  Yes, inflation has changed purchasing power that much.  Inflation compounds so even a 2% annual inflation rate would more than double nominal costs in 40 years.  In the late 1970’s we had some years of inflation in the double-digits.  So really, the graph is telling us the opposite of what Stossel wants us to believe.

The second big problem is that Stossel is assuming that the all money spent on education goes to buying improved test scores in math, science, and reading.  He also is assuming that the inputs, the students being educated are the same in 1970 as in 2010.  They aren’t.  He ignores that we might be paying for something else in addition to math, reading, and science test scores.

Stossel then goes on the attribute all of the problems to education being a government monopoly.  Again, he ignores facts. Facts are inconvenient for Stossel.  Competition has been brought to K-12 education in many areas. Maybe not as much as he would like, but it’s a significant change since 1970.  As his test scores indicate, it hasn’t helped much.

Finally, I want to note that it’s poor practice to not cite your sources and more precisely define your data series.  The graph is labeled “Source: NCES”.  NCES is a huge website and archive of a lot of data.  Stossel doesn’t give a source. Is it because he wants us to take him at his word and not verify or check it out for ourselves? He doesn’t even label what the spending series is to which he refers.  I am assuming it is a “spending per pupil over 12 years” type of series.  A search of NCES for a series labeled as he has it turned up nothing.

I find it enormously ironic that Stossel would make such elementary errors as to not deflate a data series or to not label his measures precisely.  That’s what we demand in principles of economics courses.  What makes it ironic is that on August 23 Stossel takes Congress to task for being “economic illiterates” and not having degrees in economics or business.  Pretty rich stuff from a guy with only a psychology degree who makes elementary economic errors.

Obama’s So-Called Keynesian Stimulus Efforts Aren’t Very

The simple version of Keynesian economics suggests that if the economy is suffering from too little economic activity and high unemployment there are some policy options.  Specifically Keynes suggests there are three general kinds of policy options:

  1. The central bank (The Fed in the case of the U.S.) could lower interest rates and create money by buying bonds on the open market.  This is called stimulative monetary policy. It is supposed to work by making private sector borrowing more attractive and more profitable so that businesses in particular increase their spending on business investment goods like equipment and factories.
  2. The government could increase it’s budget deficit by borrowing more money and cutting taxes.  This is fiscal policy by tax cuts. It works by putting more cash in the hands of households and firms (increases their after-tax income) who then increase their spending.
  3. The government could increase it’s budget deficit by borrowing more money and directly spending the money itself, either by direct transfer payments to needy individuals, or by buying things like new dams or construction projects, or by hiring the unemployed itself. This is fiscal policy by spending.

There’s nothing to stop a country from pursuing all the above options simultaneously if it chose.  But not all of these options are equal in either effectiveness.

NOTE: This is old-style John Maynard Keynes style Keynesianism, not the  “New Keynesian” theories that have dominated some academic circles in the last couple decades. It’s also based on the real thing, not the caricature that it’s opponents paint which is usually without foundation. 

NOTE 2: It’s really not a good idea to try to simplify Keynes.  When you do, you’re likely to over-simplify and really miss powerful insights and nuances.  Nonetheless, I will plunge ahead with full knowledge of the risk.

The real richness of Keynesian theory though lies not just in these prescriptions, but the analysis of when to use which one, whether it is likely to work, and under what conditions.  The first option, monetary policy, is to be preferred in cases of  mild recessions when interest rates are “normal” and the slowdown is largely for mild, temporary factors such as an outside economic shock. Monetary policy is quick and easy to implement. It’s also relatively easy to reverse course when the time comes.

Keynes had two key insights about monetary policy though that are highly relevant to our present situation.  Monetary policy can be become impotent if interest rates drop to near zero and we get into a liquidity trap.  This is when people and firms become fearful of the future and come to expect continued weakness or even GDP declines and deflation.  In a liquidity trap, people just sit on money rather than spend or invest it.  Monetary policy is relatively ineffective in such cases. We have been in a liquidity trap since late 2008 and that’s why the record 3 years of a virtually zero Fed Funds interest rate and The Fed’s QE1 and QE2 programs haven’t worked. Liquidity traps aren’t common, but they do exist and they aren’t extinct.  We were in one in the 1930’s Great Depression and Japan has struggled with one for the last 15+ years.

Keynes also had insights about the two fiscal policy approaches, tax cuts vs. increased spending.   In particular, tax cuts will only be effective to the degree that households and firms actually spend the money.  If they use the money to pay down debts or to save, then it really won’t improve conditions.  Later research in the 1950’s and 1960’s strengthened these insights. Later research showed that it also makes a big difference who gets the tax cuts and whether they think the tax cut is permanent.  Temporary tax cuts are much less effective than permanent ones because people tend to save them more.  Also, high-income individuals tend to save more of the tax cut (proportionally) than more desperate lower-income folks. Finally, later research showed that when a recession comes about because private debt got too high, then tax cuts are least effective.  Notice a pattern here?

The fiscal policy “stimulus” efforts that we have pursued since the Great Recession began have been very, very heavily tax-cut oriented.  Bush’s original stimulus effort in early 2007 in an effort to “nip the recession in the bud” was all tax cuts.  The Feb. 2009 stimulus bill of Obama (the ARRA) was between 40% and 50% tax cuts.  The meager effort passed in Dec 2010 was all tax cuts. And now, the proposal is again very tax cut heavy.  Not only have the fiscal stimulus efforts been heavily tax cut-based, but the cuts have temporary cuts targeted at either high-income folks or only offering a meager amount to low-income folks.  Further, we still have a huge private sector debt overhand that people want to pay down before they spend more. In sum, the dominant response which many have labeled as “Keynesian” really hasn’t been what John Maynard Keynes suggested. Many have asserted that “Keynesian policies don’t work” and cite our weak economy despite several fiscal policy stimulus attempts as proof.  But that’s not really a valid test.  It’s like claiming some physician is a total quack because you took pills like he recommended but you didn’t take the exact same pills as he recommended. You took something else. Now you’re still sick.  It’s not the physician’s prescription that failed, it’s your refusal to follow the prescription and the diagnosis that failed.

Critics will counter with a “yes, but there was still some spending stimulus in the Obama bills and our failure to fully recover is proof the fiscal spending as stimulus prescription is quackery.”  But have we really had an increase in government spending anywhere near large enough to fill the gap?   Let’s look at some trends (courtesy of Brad Delong):

We simply have not expanded government purchases as a share of potential GDP in this downturn:

FRED Graph  St Louis Fed 4

 

The graph shows the relative changes in share of GDP of four key portions of GDP: exports, business equipment investment, government purchases, and residential construction. (everything in the graph is scaled relative to 2005 -that’s why the lines all meet at o in 2005).  The whole Keynesian idea is that if exports, business equipment investment, or residential construction go down then government purchases should go up and vice versa.  That hasn’t happened at all.  Instead, government purchases has consistently declined since 1995!.  In other words, actual changes in government purchases have not only not been a stimulus, but they have been contractionary.  Government spending policy has been contractionary for over 15 years!  We didn’t notice it because strong increases in business equipment investment and housing were doing the stimulating prior to 2006. In the period 1995-2000, it was probably appropriate in a Keynesian sense to have declining government purchases and a contractionary policy – it was countercyclical to the dot-com boom and the housing boom.

But after 2007, residential construction collapsed. For awhile in 2009 both business equipment investment and exports declined sharply.  The only appropriate Keynesian response would have been a very, very large government purchases program.  But we didn’t do that.  Instead, the so-called 2009 stimulus bill was barely enough new spending at the federal level to offset the declines and cuts at the state and local levels. Overall, government spending did not increase. It went neutral for a couple years. But in late 2010, we resumed the march to contractionary policies.  The ARRA wound down.  State and local governments accelerated their budget cuts. And Washington became pre-occupied with imaginary threats of impossible debt crises at some point 10 years from now.

To continue the earlier physician and disease metaphor, we did try a little of the prescription but we took too little.  It’s as if we went to the doctor, the physician diagnosed a very severe infection and prescribed heavy doses of anti-biotics.  We went home took a lot of aspirin instead and only a couple of the anti-biotic tablets.  Now folks want to blame the doctor and his “failed prescriptions” when we didn’t take them.  None of this is what Keynes or 1960’s style Keynesians would have recommended. To conclude that Obama has tried Keynesian policies and they have failed is dead wrong.  The policies have largely failed to stimulate and re-ignite growth, but they weren’t Keynesian.

What a Liquidity Trap Looks Like in Pictures

I want to follow up a little on my discussion of the liquidity trap that we are have been in. Brad Delong has an excellent post today called “Four Years After the Wakeup Call”.  In it he shows some graphs which illustrate very well our the liquidity trap.

Delong first serves us two graphs on the Federal Funds rate since early 2007:

The daily gyrations of the usually-placid Federal Funds market starting in late 2007 told us all that banks were really worried that other banks had jumped the shark and turned themselves insolvent.

FRED Graph  St Louis Fed 7

 

The Federal Funds rate is the interest rate that banks pay to each other when they borrow reserves from each other.  Despite the name, the rate isn’t set by The Fed. It’s set by market supply-and-demand.  It’s a large and brisk market.  When the Fed Funds rate is high (or at least rising), we can infer that banks need and are desperate for reserves, typically because they have profitable opportunities to make loans based on those reserves. When The Fed Funds rate is low and/or dropping, it means that a lot of banks have excess cash on their hands and don’t see any useful or profitable ways to use that money. In other words, a low Fed Funds rate means banks are willing to lend their reserves to other banks because it’s better than nothing and they don’t see any good ways to loan out the money. At the same time, a low rate also shows that few banks are interested in borrowing – again because they don’t see much useful to do with it.  While The Federal Reserve doesn’t set the funds rate, it does set the interest rate for the alternative: direct borrowing from The Fed.

What we see from the first graph is that things were cruising along in early 2007 and then mid- to late 2007 (August to be exact), the rate starts dropping.  We’re moving toward a recession.  Banks are finding it harder to make good loans so they don’t want to borrow more reserves.  Banks start hoarding their cash and assets.  So instead of balance sheets that are full of loans, bonds, and securities, the banks decide they want/need more cash.  Their reserves grow in order to provide a cushion for what was then being seen as the inevitable losses on mortgages and mortgage securities.  Things appear to stablize and then in Sept 2008 comes the Lehman moment.  Fed Funds rate goes virtually to zero.  It’s been stuck there ever since.  Banks have plenty of reserves. They have the cash to lend.  There’s no willingness to lend (banks don’t see many credit-worthy borrowers) and there’s little interest or demand to borrow.

The Federal Reserve has responded during the same period by creating new base money like crazy.  [NOTE: Contrary to the fears of the inflation-fearful crowd, it’s not really “money” until it’s in circulation with the public. It’s only bank reserves – the monetary base.  It creates the ability to create money for the public, but that would necessitate having a bank lend it first. ]  Again Delong shows up graphically just how The Fed has been willing to create new monetary base:

And while the Federal Reserve has taken the monetary base to previously-unimaginable levels–up from $900 billion to $1.7 trillion in late 2008, up to $2 trillion in let 209, and up to $2.7 trillion in early 2011–it has never adopted Milton Friedman’s recommended policy that it start buying bonds for cash and keep buying bonds for cash until nominal spending is on the path that the Federal Reserve wants it to be on:

FRED Graph  St Louis Fed 5

We only need one more graph: GDP.  More precisely a comparison of GDP to an estimate of what GDP could be if we were at full employment and operating at our long-term trend.  Again Delong:

And so right now nominal GDP is $15 trillion/year when it ought to be $16.7 trillion/year:

FRED Graph  St Louis Fed 6

I’ll save inserting the employment graph here.  I’m sure you all know what it looks like. Same story.

And that story is that we had signs of trouble 4 years ago.  Three years ago things went really into the tank.  The economy seriously declined until mid-2009. Ever since then, it’s struggled to hold on.  There really isn’t any recovery.  It’s just going sideways.  We have, in effect, taken a huge chunk of the economy, a huge number of workers, put them on the sideline and said “we’re not interested in you participatin anymore.  We don’t want or need your contribution. We’re happy being smaller”.

So we’ve had monetary stimulus efforts, we’ve had low interest rates, we’ve had the central bank create base money.  There’s plenty of cash out there.  But it’s all in the banks. It’s in deposit accounts. It’s in reserves.  It’s not working. It’s not being used to buy things. It’s not being used for consumption or investment. It’s just sitting around impotent.  That’s a liquidity trap.

Mainstream economic theory, the stuff called “New Classical” or “New Keynesian” (never confuse “New Keynesian” as being “Keynesian”), says keeping interest rates this low for this long would /should fix everything by now.  For over 30 years now, the dominant, orthodox view in the academic and professional world of economists has been that monetary policy exercised by a wise central bank can fix all.  Any weakness in the economy can be solved via lowering interest rates and having the central bank create new bank reserves.  These “modern” theories told us that the concept of a “liquidity trap” was nonsense, a relic of some past era and/or the invention of some crank called Keynes.  These theories claimed that everybody was perfectly rational, all markets (particularly financial markets) were efficient, and uncertainty/risk about the future was unimportant.  They were wrong. We are left with the ideas of the mid-20th century, the stuff that we were told to forget about.  Again Delong:

Four years ago nearly all mainstream economists would have said that, even though the situation appeared serious, by now the economy would be back to normal. …

Very few of us thought that it would be long and nasty…

And as it turned out to be long and nasty, recent economic theories of macroeconomics have fallen like tropical rain forests. The–already implausible–claims that downturns had real causes? Fallen. The claim that downturns lasted only as long as workers misperceived their real wage? Fallen. The claim that the labor market cleared in a small number of years? Fallen. Those of us who believed that the long run came soon, that the cause of downturns was transitory price-level misperceptions, or that downturns had real causes need now to be looking for new jobs, or at least new theories.

And we are left with the live macroeconomic theories being those of the 1960s, at the latest. This is embarrassing for those of us who want to belong to a profession that is a progressive science, rather than an analogue of medieval barbering.

So what would the economic theories of the 1960s and before tell us to do?

  • Milton Friedman: monetary expansion, and more monetary expansion–quantitative easing as deep and as broad as necessary to get nominal GDP back to its trend.
  • John Maynard Keynes (or at least one of the moods of Keynes): have the government borrow and buy stuff, and keep buying stuff until real economic activity is back to some normal trend value.
  • Jacob Viner: Why choose? Do both! Print lots of money and have the government use it to buy stuff and hire people.

The odd thing is that none of those three recommended policies–all of which are sponsored by economists with the purest of purebred pedigrees–have been followed.

It’s time to do two things.  At the policy level we need to go back and try the policies that we understood back in the 50’s and 60’s (economy did pretty well back then, BTW).  Some serious, bold attempts at effective government spending would be nice instead of the weak, too-small, too-timid, niggling efforts dominated by tax cuts we’ve been doing.  And even on the monetary front, it would be more useful to do as Friedman suggested: actually have The Fed keep buying bonds for cash (real circulating money instead of just bank reserves) and keep it up until people start spending it.

On the economics side, we need to get past the perfect rationality and rational expectations stuff (and it’s absurd mathematics) that has dominated the profession.  It would be a good idea to take a more serious look at the heterodox ideas and theories that actually did foresee the crash, the ones based upon realistic models of human behavior and models instead of the perfectly rational, knows-the-future home economicus of the New Classical and New Keynesian models.  We need to seriously look at ideas of Modern Monetary Theorists (MMT), Minsky, the Post-Keynesians, and the behavioral economists.

 

 

Yep, This Is What A Liquidity Trap Looks Like

People, businesses, and banks simply aren’t investing in the sense of putting financial wealth to work in productive purposes with the intent to produce goods and thereby produce profits.  Instead, folks, the ones who have financial wealth that is, are just sitting on cash.  They’re putting it in the bank at record low interest rates. The banks don’t want the extra deposits and are trying to discourage it.  Meanwhile the banks are just turning around and putting the money on deposit at The Federal Reserve where it sits idle. This is called a liquidity trap.

Calculated Risk directs us to this report:

From Scott Reckard at the LA Times: Bank deposits soar despite rock-bottom interest rates

Americans are pumping money into bank accounts at a blistering pace this year, sending deposits to record levels near $10 trillion …

In the last three months, accounts at U.S. commercial banks have increased $429 billion, or 10%, almost double the increase for all of last year.

The large amount of cash only adds to expenses such as paying for deposit insurance premiums. … [banks] have slashed interest payments to discourage customers. Wells Fargo & Co. … halved its payments on one-year certificates of deposits to 0.1%; Citigroup … dropped its payment to a paltry 0.3%.

[Some banks are] stashing it in a safe but unrewarding place: Federal Reserve banks, which are paying them an interest rate of just 0.25% to tend the funds. Such deposits rose to more than $1.6 trillion at the end of August from about $1 trillion a year earlier, according to the Fed.

So why is this really significant?  Simple. Neo-classical/neo-liberal macro theories, the theories that conservatives have been relying on, basically say this can’t happen. It’s irrational and according to those models, people and firms never act irrationally.  So who or what theories say a liquidity trap is possible?  Keynesian theory.  Yes, the whole idea of a liquidity trap in which macro circumstances are such that firms and households would rather hold cash than put it to some productive investment purpose comes from Keynes.

A liquidity trap is also significant because it means that monetary policy, the raising/lowering of interest rates and the purchase/sale of bonds by the central bank, isn’t very effective in a liquidity trap. The Federal Reserve can make funds available for investment, but it can’t force banks to lend or firms to invest or households to spend.  Monetary policy in times of a liquidity trap has been likened to pushing on a string.  The string doesn’t really move much.  Again, neo-classical models don’t allow for the possibility of a liquidity trap.  Indeed they start with assumptions that pretty much exclude the possibility of there ever being one.  Models and theories that start with the assumption that “A” can never happen aren’t of any use in trying solve “A” when it really does show up.

Why do people seek money instead of useful investment in a liquidity trap?  Simple. There are two reasons why firms and people would seek to hold financial wealth as money instead of useful, profitable investments.

  • First, profitable investments require a growing economy and expectations of a growing economy.  If firms and people have no confidence that the economy will grow or that any growth will last, then they don’t invest. No need to expand capacity at the business if you won’t need the extra capacity.
  • Second, if you expect the economy to get worse and/or have deflation happen, then it makes enormous sense to be cash instead of things.  Cash actually is profitable and gains in real purchasing power when deflation happens.  So I would interpret from the above data that people, banks, and firms are expecting more deflation and not expecting inflation.

What to do in a liquidity trap?  Theoretically (and Krugman/Delong push this idea)  you could have the central bank (Federal Reserve) make some sort of commitment to higher future inflation.  But that’s in theory only.  It’s not been proven.  What’s experience say?  We have a choice.  Suffer through it, experience a prolonged depression that could easily last a generation, and make do with lower living standards for the vast majority but see the really wealthy become even more wealthy.  This is the story of the Long Depression in the late 1800’s.   Or, we could turn to aggressive fiscal policy. Keynesian style spending for job creation.  That’s been proven.  It worked in the 1930’s until it was abandoned in 1937, it worked in 1939-1940 with the start of WWII (not my choice of spending priorities), and it worked quite well in the 1950’s through the 1970’s in achieving a higher average annual growth rate in GDP than has been achieved since.

Unfortunately, too many economists, and the politicians that follow them, are so married to their ideologically-based models that they persist in the theory even when the facts contradict it.

Stimulus Requires More Than Taking Your Foot Off the Brakes

Last week I discussed how I think the President’s jobs proposal, the American Jobs Act, will be less than stimulating.  I updated it here.  I based my analysis on what economists call “back of the envelope” calculations – quick simple estimates of the key variables using rounded numbers.  Now the folks at Goldman Sachs research have put the proposal through their more sophisticated and complex econometric models.  And they come to … roughly the same conclusion.  Paul Krugman at the NY Times observes:

Goldman Sachs (no link) has a nice chart showing just how much fiscal policy has been a drag on the economy since the second half of last year, and also shows that the Obama jobs plan, even if enacted in full, would only be enough to put it in neutral:

Just worth bearing in mind.

The graph (the line) shows the effect that total government fiscal policy, including federal, state, and local, has had / will have on GDP growth rate.  In 2009, Q1-Q3, governments were having a very positive effect on GDP growth, adding up to 2.5 percentage points to the GDP growth rate.  By 2009 Q4, though, this stimulus effort had deteriorated and was starting to have a negative effect, slowing GDP.  Initially this was because state and local spending cuts were overwhelming the federal increases in spending.  But the 2009 stimulus bill ran it’s course and the feds joined the austerity party and started cutting spending along with state and locals in late 2010.  In 2011, our problems have been the austerity programs, the spending cuts at state, local, and federal level. Government has had it’s foot on the brakes trying to slow an already weak economy.  It’s worked. The economy is coming to a halt.

Unfortunately, the proposed jobs program isn’t really much of a stimulus. It’s too weak. It’s too small. And it’s focused too much on tax cuts that won’t be spent instead of spending.  The blue line above shows the likely effects.  Even if passed (a near impossibility given the Republican majority in the House), it will only reverse the contractionary effects of spending cuts without adding any new stimulus to grow GDP further.

Stimulus is supposed to be about speeding up GDP growth – hitting the accelerator.  Simply taking your foot of the brakes isn’t the same thing as hitting the gas.