Wednesday, February 4, 2009

Heritage and the National Review Adopt the Treasury View

David Freddoso of the National Review interviews Brian Riedl of Heritage (not Cato - my apologies) in the The Case for No Stimulus:

The grand Keynesian myth is that you can spend money and thereby increase demand. And it’s a myth because Congress does not have a vault of money to distribute in the economy. Every dollar Congress injects into the economy must first be taxed or borrowed out of the economy. You’re not creating new demand, you’re just transferring it from one group of people to another. If Washington borrows the money from domestic lenders, then investment spending falls, dollar for dollar. If they borrow the money from foreigners, say from China, then net exports drop dollar for dollar, because the balance of payments must adjust. Therefore, again, there is no net increase in aggregate demand ... There is this notion that the redistribution of money from savers to spenders creates new spending. But that assumes that people store their savings in their mattresses. That may have been true in the 1930s, but today, people use their savings to pay down debts or invest. Or they put it into the bank, who in turn lends it to others to spend. Therefore, savings circulate through the investment side of the economy, which counts just as much in the GDP as the consumption side of the economy ... The government is going to have to raise interest rates in order to convince people to lend them the full amount they need. We’re already facing a deficit of $1.2 trillion this year, and 700 billion next year. We borrowed $700 billion for TARP, and now we’re going to borrow $800 billion for this stimulus package.

Hang on a second – Riedl notes that Keynesian insufficiency of aggregate demand may have existed in the 1930’s so that an increase in national savings does not automatically become investment demand but he argues for complete crowding-out ala the classical full employment model is the only relevant view for today’s economy. Has he been asleep for the past couple of years? Does he not know how far the employment-population ratio has declined or how low Treasury bill interest rates are? I know we should expect incredible stupidity from the National Review but this one really takes the cake!

Footnote: Thanks for Tom Bozzo for noting that Riedl is with Heritage and not Cato (I do get these two confused at time). It also seems that Tom's Angrybear colleague Sammy recognized Riedl's appropriate association even if Sammy did not realize (at first) that Riedl's argument was the discredited Treasury view.

Update: While I should thank Tom Bozzo for linking to this over at Angrybear, I am appalled by the critical comments from folks who have not been following this discussion of how Eugene Fama stumbled in his revival of the Treasury view. Apparently, my former colleagues at Angrybear do not read Brad DeLong who has even written a paper on this.


Tom Bozzo said...

Indeed. Though actually Riedl's association is given as Heritage Foundation; for all Cato's issues, they're, I dunno, like Arnold Kling and Heritage is Don Luskin.

Westophanes said...

Yea, also, if business investment is very low, as it is now, then crowding out seems even less likely. Businesses don't want to invest--they are afraid to--so the government has to invest in the places they are not to stimulate the economy. Second, can't the government monetize the debt by buying corporate bonds (and thus raising bond demand) after selling bonds to raise the money (which lowered bond demand). That would bring interest rates back down and crowd out a lot less.

Btw all of this is stuff I just read last week in my macroeconomics textbook.

ProGrowthLiberal said...

Tom - thanks. See my footnote as your AB colleague got Riedl's association correct but failed to see the obvious flaw in Riedl's "reasoning".

Anonymous said...

it's good that they write this stuff.

it gives us an idea how seriously to take their "thinking."

i had no idea there was a fixed amount of "money" in the economy. or that when people stop spending because they have no jobs or stop investing because they are afraid no one is buying, that that was it. the end.

of course i can save my excess money in the bank for less than one percent interest, thus making it available for all the investors out there... oh, wait.

i suspect these little stories are not meant for people who are literate, but are kind of fairy tales to read to the children so they will understand why dad needs a tax break today.

TheTrucker said...

The abject stupidity created by conservative neoconomists for their cult members seems to be a constant. That is what Heritage and Cato are paid to do and it is what the editorial writers on the Reich are paid to do. There are no such institutions on the left or in the middle. There are also no PUBLIC institutions that market the Keynesian points of view and no PUBLIC institutions that market the centrist view. By PUBLIC I refer to media that can actually reach and influence the populous. That lack of "publicity" does not spring from an inability of the public to understand simple economic principles. It springs from a lack of profitability inherent in the exercise.
Cato and Heritage are well funded by those who derive large incomes from the government policies shaped by a populous that has been miseducated.

But what really rankles is the use of the universities in corrupting the economics profession itself. "Comparative Advantage" and "Ricardian Equivalence" are shining examples of autistic theories that are simply incompatible with reality. And the "Cambridge Capital Controversy" is yet another example of proof against neoclassical nutters that is simply ignored. It is very sad to see people who should know better than to swallow neoclassical nonesense actually doing so. Most especially "Comparative Advantage" (trade between sovereignties being treated as trade between trades within a sovereignty) is the prominent example.

Bruce Webb said...

PGL the various Anons at Angry Bear are not for the most part ignorant in the sense of not following the argument. They simply are committed to their glibertarian belief system come what may. Except for a few who in PRS mode simply trying to disrupt the dialog.

Anonymous said...

Looks like the real world is adopting "The Treasury View" too.

"The US Treasury on Wednesday opened the floodgates of government bond issuance, revealing plans for a record debt sale in February and more frequent auctions in the months to come.

The announcement came amid growing fears about US government deficits and sent the yield on the benchmark 10-year Treasury note rising to 2.95 per cent, up from just over 2 per cent at the end of December.....The Treasury Borrowing Advisory Committee expressed concern on Wednesday over the sharp jump in net borrowing needs – which market analysts estimate could reach $1,500bn to $2,500bn for the 2009 financial year.

Traders are particularly concerned about the appetite for Treasuries among foreign investors, who hold more than half the outstanding $5,500bn in Treasury debt."

Anonymous said...

And so do the economic dolts at CBO:

"President Obama's economic recovery package will actually hurt the economy more in the long run than if he were to do nothing, the nonpartisan Congressional Budget Office said Wednesday.

CBO, the official scorekeepers for legislation, said the House and Senate bills will help in the short term but result in so much government debt that within a few years they would crowd out private investment, actually leading to a lower Gross Domestic Product over the next 10 years than if the government had done nothing."

ProGrowthLiberal said...

Sammy comes over to Econospeak and cherry picks a quote from the rightwing Washington Times? Let's put this in context:

"CBO, the official scorekeepers for legislation, said the House and Senate bills will help in the short term but result in so much government debt that within a few years they would crowd out private investment, actually leading to a lower Gross Domestic Product over the next 10 years than if the government had done nothing."

So even the Washington Times admits that fiscal stimulus will raise real GDP in the short-run. Now if the stimulus is maintained for a decade, even the most ardent Keynesian would note we'd get long-term crowdingg-out.

I'm not sure if Sammy realizes all of this so I don't want to accuse him of mendacity. But this is the kind of shameful garbage that is ruining what Angrybear started.

ProGrowthLiberal said...

Oh - and how did we miss this from the Wash. Times: "CBO said there is no crowding out in the short term, so the plan would succeed in boosting growth in 2009 and 2010."

This refutes everything Riedl said and yet AB's Sammy can't bring himself to admit that this line was in the article he cited.

Anonymous said...

"This refutes everything Riedl said"

What???? The CBO validates Riedl - the extra deficit spending/borrowing crowds out private investment. It just figures a 1-2 year lag time.

Riedl doesn't specify any time frames for his analysis that deficit spending doesn't raise GDP, obviously CBO agrees.

TheTrucker said...

OK. I am getting real close to throwing in the towel on fiscal and monetary policy. The contradictions and spin are becoming a little irrational.

I see people terribly concerned about the government having to borrow excessive amounts of money and nobody being there to lend this money. That is the new "crowding out" version (or maybe it was always like that). What is rather obtuse about this is the fact that the US dollar is a fiat dollar that is backed by nothing but government (the US government can close down the Fed tomorrow and reopen it the next day under new management if that is what it takes). As such, there really isn't any such thing as monetary policy. That ended in 1973 as the last link to gold was severed.

If we can assume that we have a representative form of government then all is well. The country will not be placed under martial law and we will be able to place people into the House of Representatives and the Senate that will impeach the (P)resident and vice president in order to have the new (P)resident be the speaker of the House.
If that is the case then the money will not be an issue. We will empower the Congress to appropriate funds (just like it says in the Constitution without borrowing)thus devaluing the existing money. The Chinese and the other holders of T-Bills will not be real happy about that and so they will continue to lend or take the loss. I care not which one is the case.

It has taken a long time to get to this point where the dollar is going to lose 50% of its current value. But that will take care of the trade imbalance and we Americans will be just fine. If interest rates rise too much then the Fed will buy T-Bills with money created from the ether. The dollar will lose value as it should and the Chinese will lose exports and the value they thought they had in T-Bills. As the dollar sinks in value all those real estate loans will look pretty good.

Bottom side inflation (stimulus) is the correct across the board answer to the real problems created by the Republicans. If we get some new infrastructure out of the deal that will be a bonus.

Bruce Webb said...

PGL there is a world of difference between people with front page privileges at AB and guest posters. Sammy is not a 'colleague' and his hosted post has been the subject of some back channel communications. I don't think you will have similar unmediated channeling from Heritage going forward.

In any event there are a lot of possibilities for some cross posting between Econospeak and Angry Bear. After all the Center-Left (AB) obviously at least touches with the Left (EconoSpeak). Just as Dan is looking for some smart conservatives. Sammy channeling Reidl maybe wasn't the right start,

ProGrowthLiberal said...

Bruce Webb has this right - "Sammy channeling Reidl maybe wasn't the right start". Note Sammy's 10:46 PM comment last night refuses to get a simple point but then I put up a follow-up post today after reading what the CBO really said. Hopefully Sammy will finally get the distinction that Brian Riedl never acknowledged.

Anonymous said...

Question one -- does increased government borrowing mean less money for private sector borrowing and thus decreased private sector investment? In other words, does government borrowing crowd out private sector investment? This question is rooted in an accounting identity that savings must equal private sector investment plus government spending less taxes (adjusted for international capital adjustments).

To answer this question start with a cyclical conceptual model of the economy.

1. Produce GDP -- Goods and Services are produced
2. Distribute Income -- Income equal in value to GDP production is distributed as wages, profits, interest and rental payments

FINANCIAL FACILITATION -- the sources of money and credit
3. Deposit Income --Income is deposited with financial intermediaries to be spent (money to checking), saved or sent to the government as taxes.
4. Grow Money Supply -- Additional money is created by the Federal Reserve and fractional reserve banking system.

CONSUMPTION -- the uses of money and credit
5. Deploy Money -- Consumers, businesses, government and foreign entities withdraw and borrow from financial intermediaries for consumption and to invest in capital (such as technology, plant and equipment).
6. Consume -- Goods and Services produced in GDP production (step 1) are consumed or go to inventory.

NEW PRODUCTION (and income)
7. Deploy Resources -- Employers (businesses, government and entrepreneurs) decide how many employees and other resources are to be used to produce new goods and services.
8. Produce New GDP -- New Goods and Services are produced creating a new GDP level

Two dynamics are critical to understanding the current crisis in contrast to a normal growing economy. First, in a normal growing economy money deployed (step 5) is greater than income deposited (step 3). Second, new GDP produced (step 8) is greater than previous GDP produced (step 1).

The current crisis arose because the reverse happened and could not be halted with monetary policy. Suddenly money deployed (step 5) was less with each cycle leading to lower new GDP produced (step 8) than previous GDP produced (step 1). This discontinuity accelerated. The Federal Reserve aggressively lowered interest rates to reverse the discontinuity. It did not work. Interest rates were taken to zero. But interest rates could not go below zero. Zero is not sufficient to motivate growth in money deployed (step 5) to increase consumption (step 6) to deploy more resources (step 7) to grow new GDP (step 8). The economy is still contracting.

This reversal also shifts the phenomenon of "crowding out". In a normal growing economy government competes with all other players to deploy money (step 5) which supply was grown each cycle (step 4). In the current crisis, the other players are not increasingly but instead are decreasingly deploying money (step 5) with each cycle. Without government stepping in to make up some of the difference, money goes idle or stated differently monetary velocity drops. "Crowding out" does not occur until other players (consumers, businesses and foreign entities) start to increasingly deploy money (step 5).

Bruce Webb said...
I don't know what CBO Report the Times is citing. It doesn't seem to be this one.

Under CBO's scoring of the Senate Plan the net effect on the deficit of the legislation is as follows:
2009: $233 billion
2010: $461 billion
2011: $141 billion
2012: $26 billion
2013: $16 billion
2014: $10 billion
Sammy and/or the Times are talking out of their hat here. $26 billion is not going to crowd anything out.

Bruce Webb said...

The Washington Times doesn't have a link to the CBO document but clearly misrepresents the result of an earlier letter later in the article.

I suspect the "crowd out" language was inserted by the reporter based on not understanding the implications of the analysis.

Color me skeptical.

Bruce Webb said...

Here is the actual language. While 'crowd out' is used the whole thing doesn't support the tone of the Wash Times piece which implies total crowd out. In any event I'll trade fractional changes in GDP ten years out for real boosts in GDP in the meantime. I am a lot more worried about getting through the fall and winter.
In contrast to its positive near-term macroeconomic effects, the Senate legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt. To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to “crowd out” private investment—thus reducing the stock of private capital and the long-term potential output of the economy.

The negative effect of crowding out could be offset somewhat by a positive long-term effect on the economy of some provsions—such as funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run. CBO estimated that such provisions account for roughly one-quarter of the legislation’s budgetary cost. Including the effects of both crowding out of private investment (which would reduce output in the long run) and possibly productive government investment (which could increase output), CBO estimates that by 2019 the Senate legislation would reduce GDP by 0.1 percent to 0.3 percent on net.