Lowballing Estimates of Potential Output

Simon Wren Lewis notes one of the Cameron excuses for fiscal austerity:

As I noted in my previous post, the very big government budget deficit in 2010 was largely the result of the recession. That fact is difficult to square with the myth that the coalition government rescued the economy from an impending financial crisis, so it is important to push another explanation for the large deficit: that it reflected the profligacy of the previous government.

The Great Recession increased the deficits for a lot of nations including those that undertook the Herbert Hoover economics of fiscal austerity during a period of weak aggregate demand. Over 60 years ago, E. Cary Brown noted that an analyst needs to separate the automatic stabilizer effects on the actual deficit from changes in fiscal policy. This is often accomplished by examining the structural surplus (deficit). Simon also notes:

The only way you can sustain the myth that Labour was fiscally profligate is by suggesting that immediately before the recession the UK was experiencing a massive boom. In an economic boom tax receipts are high and spending on transfers low, so the budget should be in surplus. If it is in fact in significant deficit, that indicates serious fiscal laxity.

He continued with a criticism of how the IMF changed it estimate of the UK’s potential output, which we also noted. Simon’s latest continues the discussion:

The first point is to stop talking about GDP, and start talking about GDP per head ... As the chart shows, we have failed as yet to make up for any of the ground lost not just in the 2009 recession, but also ground lost as a result of fiscal austerity in 2010 and 2011 … So we have not really seen a recovery. Maybe the pessimists are right, and we will never recover any of that lost output, but still you do not call it a recovery. I can put it another way. Quarterly growth in GDP per head since the beginning of 2013 has averaged about 2% at an annual rate. That is below the average growth rate since 1955. A recovery from a deep recession would have growth rates well above the long term average … the prosperity of the average citizen in this country has hardly increased over the period of this coalition government - a result that is totally unprecedented since at least WWII. As recoveries from recessions go, this does not seem like a recovery worthy of the name. Yet we keep being told by mediamacro that the Coalition’s strong card is its economic record!

As we noted when we presented Bill Martin’s aggregate demand explanation versus the productivity pessimist story: Bill comes down on the latter explanation as does Paul and Simon. The former view is a Real Business Cycle tale of negative productivity shocks. We heard those stories 30 years ago but the US economy finally did fully recover. Let’s hope the same occurs for the UK economy. But let’s suppose for a moment that the productivity pessimists are correct. Then Cameron’s government should cease gloating how well the UK economy is doing as a permanent fall in real income per capita is not good news. Let me just add that if this productivity pessimism argument was valid, the expansionary monetary policy from the Bank of England should have been inflationary. But the record shows it was not. Paul Krugman adds a lot more but I found this part of interest:

Chart 3 shows estimates of our old friend the cyclically adjusted primary balance since 2009. I’ve included three sources – the IMF, the OECD, and Britain’s own Office of Budget Responsibility – just in case someone wants to argue that any one of these sources is biased. In fact, every one tells the same story: big spending cuts and a large tax rise between 2009 and 2011, not much change thereafter.

Paul’s chart 3 were drawn from three measures of the cyclically adjusted primary balance that assumed the UK output gap was severely negative in 2007 even if Paul noted why these measures were likely low balling potential GDP. Of course, fiscal impact is about the change in fiscal policy but leave the UK for now. We are having a few debates about U.S. monetary policy and inflation that revolve around low ball estimates of potential GDP. Our two graphs show how I would estimate the output gap for two 7 year periods, which is by using the CBO estimate of potential GDP. John Taylor has been at this argument for way too long:

the Fed has returned to its discretionary, unpredictable ways, and the results are not good. Starting in 2003-05, it held interest rates too low for too long and thereby encouraged excessive risk-taking and the housing boom.

There have been a lot of effective rebuttals to this claim. Our first graph suggests that we did not see the output gap disappear until the end of 2005 and the period of excessive demand was very short lived and was already being offset by the FED’s increase in interest rates. Yet we see this canard:

There are multiple measures of the output gap that show the U.S. economy overheating during this time. Below is a figure from this article that compares the real-time and final measures of the U.S. output gap. Everyone shows ex-post an overheating economy during the housing boom.

David Beckworth had earlier argued we were witnesses a series of positive productivity shocks and yet he wants to argue the CBO overestimated potential output. Something does not add up. Our second graph relates to something from perhaps the last honest supply-sider - Bruce Bartlett:

In this article, the author reviews the continuing controversy over the Reagan tax cut. Republicans often assert that it was so expansionary that there was no revenue loss, something the Reagan administration itself never claimed. The truth is that the tax cut lost a lot of revenue, but helped the economy transition from high inflation to low inflation at an unexpectedly low economic cost.

Paul Krugman rightfully points to the first part of this as evidence that the three stooges (Lawrence Kudlow, Art Laffer, and Stephen Moore) misrepresent the 1980’s record but I would question Bruce’s claim that the economic cost of the disinflation was low. In fact Paul noted that the cost was expected:

Keynesians came into the Volcker disinflation — yes, it was mainly the Fed’s doing, not Reagan’s — with a standard, indeed textbook, model of what should happen. And events matched their expectations almost precisely.

Using the CBO measure of potential GDP during the 1980’s, the Volcker disinflation involved what Paul calls a PLOG – a prolonged large output gap.

Truthiness, media framing and the political economy of economics

Concealed deep in the bowels of the ivory tower is this little-known academic endeavor sometimes referred to as "political economy of communications." These guys study "media bias" or "media framing." They've even done content analysis that goes beyond harping at the very serious personhood of this or that individual columnist or newspaper.

For example, in Framed! Labor and the Corporate Media, Christopher Martin identified Five Dominant Frames in the media coverage of labor disputes:

(1) The consumer is king;
(2) The process of production is none of the public’s business;
(3) The economy is driven by great business leaders and entrepreneurs;
(4) The workplace is a meritocracy; and
(5) Collective economic action is bad.

Stated somewhat more evasively, these also happen to be the tenets of the dominant frame in contemporary economics  -- the "equilibrium price-auction view of the world" (aka subjective preference theory or conservative ideal). Surprise, surprise!

Has it ever occurred to anyone that the dominance in elite economics of a particular economic ideology may owe more to the dominance of a congenial corporate media frame than to any inherent theoretical elegance or empirical support? Of course not.

There is this peculiar rhetorical mise en abyme in which editorial punditry takes its Delphic authority from what "economists say" while what they say simply regurgitates something they read (over and over again) in the press.

"I'm an economist and I'm O.K. I say what I've been told that 'economists say'."

Wouldn't it be worthwhile to ask whether the economics practiced today is, in effect, a subsidiary of the corporate mass media rather than an independent academic discipline?

"Let’s stop making a fetish of national income statistics and percentage rates of growth”

by Henry Hazlitt.

Allan Sloan Joins The WaPo VSP Truthiness Gang On Social Security

Allan Sloan, semi-retired from the Washington Post wrote a report today entitled "Soaking the 'rich' won't fix Social Security."  In it he announces that he is "launching what I hope will become a series of Social Security truth-teller articles."  He poses himself as in the obviously Very Serious Center between "conservatives [who] agitate to cut benefits and liberals [who] agitate to raise them."  Unfortunately his first outing makes it look like he is engaging more in truthiness like so many other VSPs at WaPo whom he seems to be joining, such as Fred Hiatt, Robert J. Samuelson, and Ruth  Marcus, all of whom regularly bloviate obsessively on all the things that should be done to Social Security because it is so awful and messed up.  Sloan appears to be joining their Truthiness Gang.

His targets in this article are Chris Christie on the right who wants to reduce benefits for those earning over $80,000 per year, with those earning over $200,000, and Elizabeth Warren on the left, who wants to raise benefits and also raise the maximum wage cap for paying the fica, currently at $118,500.  What has him really steamed is a general idea he claims they both share that "the rich" are getting too sweet a deal out of Social Security as of now.

His evidence in his "fact-filled" report for this is an estimate he had done by Social Security actuaries on his and his wfe's own situation, with them having been at the max wage cap for 35 years.  Apparently according to this, no details on how this was calculated, the current value of their future [expected] benefits is only 75% of what they paid in, with this lowered further by his working longer and having in the future to pay taxes on his benefits.  While one could argue about this calculation, I shall not do so.  Let this be his big fact from which he argues that "the rich," or those whose wage incomes exceed the max wage and thus do not pay more in fica than anybody else at the max wage or above, are actually getting the shaft.

Now, I shall give him credit that in fact he agrees that it is not unreasonable that the Social Security system be on net a moderately progressive system, taking account of both taxes and benefits, and in fact this has been known for decades based on studies by people like my major professor, Eugene Smolensky and others dating back at least to the 1970s and re-confirmed since.  This is not really news, even if  Sloan thinks it is.

The problem comes later, in particular when he conflates in the end the political bottom line of what Christie and Warren propose.  His final  paragraph declares, "Either of these  turns Social Security from an earned benefit that is subtly means-tested into welfare.  And we all  know what tends to  happen to welfare in this country."  Ooops!

Clearly what is involved here is a matter of perception above all, and on how Christie's proposal will be perceived, simply paying no benefits at all to  people above a certain income level, that is indeed how it will be perceived: that Social Security will have become "welfare."  Indeed, this is why liberals have consistently opposed doing that, with it not at all surprising that is someone on the right, even if on the center-right, who has put this forward.  It is a recipe for draining support from the program over time.

But the proposal of Warren, with or without a benefits increase, and with or without some general lowering of the fica tax rate that could be done if the max wage cap is raised so as to still make at  least current revenues, does not lead to that outcome.  As Sloan admits, the program already is mildly progressive, and thus if one wishes to push it, already sort of a "welfare" program.  But it is not perceived as such.  Yes, raising the cap, whatever else is done, pushes the program more in that direction, makes it more progressive, more of a welfare program, but does not fundamentally and qualitatively change it from what it is now.  I would contend, and I really do not see how Sloan can claim otherwise, as long as higher income people get the benefits that they have always gotten, with no reduction in that for them, I  doubt that many of them will view Social Security as having become a "welfare program."  They may not like the tax hike and oppose it,  but as long as they get those benefits, they will not call it a welfare program because they are getting those benefits, and if there is anything a rich person does not like being called, it is a welfare recipient.

Sloan is going to have to do better than this if he is going to avoid simply being another member of the pathetic and egregious WaPo Social Security Truthiness Gang.

Barkley Rosser

So,

Why Varoufakis’ Job Was Impossible

As Greek finance minister, Yanis Varoufakis has had two responsibilities.  First, Greece’s strategy hinged on a public relations effort directed at the citizenry of other eurozone countries, to convince them that austerity has functioned as a downward vortex in Europe, and that human decency requires a resumption of growth and social provision in Greece.  Realistically or not, Syriza has counted on grassroots political pressure to counter the orthodoxy of “the institutions”.  Varoufakis was the main public face of this campaign.

Second, as finance minister, Varoufakis was the point person in negotiations with peers from the other countries.  Diplomatic etiquette, again rightly or wrongly, requires a limited public presence and clubby, consensus-building behavior behind closed doors.  It’s clear that Varoufakis’ effectiveness in the second job was sacrificed to his devotion to the first, but it would have been just as bad—worse even—if he had sacrificed the first to the second.

The two jobs are so contradictory in their demands that it makes sense to divide them between two people.  Varoufakis’ knowledge of economics and intense absorption in it is a benefit to his public role but gets in the way of being the kind of negotiating partner the creditors are looking for.  Let Varoufakis bike around Europe drumming up support for Greece, and have a publicity-shy technician parse the negotiating texts.

Of course, rearranging the personalities on the negotiating team can only go so far.  If the creditors are unwilling to bend on pensions, for instance, and neither is Syriza, even the chummiest personal relations between the parties is not going to be enough.

Banishing Varoufakis

The eurogroup finance ministers can’t take it any more: they want Yanis Varoufakis out of their sight, banished to the netherworld of YouTube and the blogosphere.  He keeps insisting that policy reforms can’t be given fiscal numbers without a credible macroeconomic forecast, which might be something for academic perfectionists, but not for grownups who have to deal with reality, like who is facing default and has to get with the program, pronto.  How can Greece claim it can’t pay its debts when there are still wages and pensions to cut?

So the Greek government said, fine, you don’t want to look at Varoufakis, we’ll make his deputy the negotiating guy, but Varoufakis will still be the team leader.  Maybe the deputy tucks in his shirt.

I wonder why Greece didn't try out this idea: give Varoufakis a new identity.  Change his name to “the institutions”, as in, you don’t have to deal with the Troika any more but now you have to submit to “the institutions”.  OK, that’s a bit strange for a personal moniker, but you could call him Charlie or Wolfgang or, hell, Maynard.  “Dear finance ministers, we have accepted your request to sack Varoufakis.  From now on you will be negotiating with 'Maynard.'”

Morning in America and Cameron’s Productivity Pessimism

I feel over 30 years younger. A recent UK debate reminds me of the infamous Reagan commercial - it’s Morning in America again. You see the Reagan tax cuts saved America from that awful 1982 recession under Jimmy Carter. Oh wait – Reagan became President before the 1982 recession. Of course the macroeconomic mix back then involved Reagan’s fiscal stimulus and a very vigorous monetary contraction with the recovery coming after the Volcker FED declared victory over inflation and eased up. The Bank of England of late has been using monetary stimulus desperately trying to offset Cameron’s vigorous fiscal austerity. And the intellectual garbage coming from Cameron’s government is being documented by Simon Wren Lewis:

The idea that austerity during the first two years of the coalition government was vindicated by the 2013 recovery is so ludicrous that it is almost embarrassing to have to explain why … imagine that a government on a whim decided to close down half the economy for a year. That would be a crazy thing to do, and with only half as much produced everyone would be a lot poorer. However a year later when that half of the economy started up again, economic growth would be around 100%. The government could claim that this miraculous recovery vindicated its decision to close half the economy down the year before. That would be absurd, but it is a pretty good analogy with claiming that the 2013 recovery vindicated 2010 austerity.

This FRED chart shows what Simon is referring to. A deep recession followed by a partial recovery with real GDP at only 1.037 of its 2007 level and real income per capita still below its level from 7 years ago. The UK economy is imitating the US macroeconomic performance 30 years ago. In 1983, we were still far below full employment but Cameron has found a bogus estimate of potential output in the UK that say they are just fine. Paul Krugman explains:

these estimates are now based on estimates of potential output, which purport to show that the British economy in 2006-7 was hugely overheated and operating far above sustainable levels. But nothing one saw at the time was consistent with this view. In particular, there was no sign of inflationary overheating. So why do the usual suspects claim that Britain had a large positive output gap? The answer is that the statistical techniques used by most of the players here automatically reinterpret any prolonged slump as a slowdown in the growth of potential output — and because they also smooth out potential output, the supposed fall in current potential propagates back into the past, making it seem as if the pre-crisis economy was wildly overheated.

Bill Martin has been following this debate for a while:

There are two sharply contrasting explanations for the continuing malaise. The conjunction of weak activity, persistent inflation and disappointing trade performance adds weight to the common view that the economy has become bound to a lower trajectory, the result of a permanent loss of productive capacity. Others believe the economy is primarily constrained by weak demand, the result of a private debt overhang and a contraction in the flow of bank credit, deflationary forces made worse by an upsurge in world commodity prices.

Bill comes down on the latter explanation as does Paul and Simon. The former view is a Real Business Cycle tale of negative productivity shocks. We heard those stories 30 years ago but the US economy finally did fully recover. Let’s hope the same occurs for the UK economy. But let’s suppose for a moment that the productivity pessimists are correct. Then Cameron’s government should cease gloating how well the UK economy is doing as a permanent fall in real income per capita is not good news.

Good To Know Eurozone Negotiations Focusing On The Really Important Stuff

Reports out of Riga about the negotiations between Greece and other Eurozone members have been rather curious.   There has been much emphasis  on how the other fin ministers do not like or get along with Yanis Varoufakis, the Greek one.  He did not go  to dinner with them.  He is the only one not wearing a tie.  Draghi does not look him in the eye.  Djesselbloem calls him by his first name in person and refers to him as "the Greek finance minister" when not in person.  The others do not like him "lecturing" them with his British education and his time in Australia, and, gosh darn it, why does  he not just up and accept their demands for full austerity for Greece!

It looks like this is more about him breaking the rules of a fraternity than about seriously coming to an agreement that most observers think is not that far away. Time for these clowns to grow up.

Barkley Rosser

WSJ on Scott Walker's Lumpy Labor Economiics

"Economists call this the lump of labor fallacy, which holds that the amount of available work is fixed. If one person gets a job, another loses it. But the addition of new workers into a market, especially skilled workers, can increase the productivity of companies in a way that expands the supply of work for everybody." -- Wall Street Journal

Except, of course, when economists "call this the lump of labor fallacy," they do not do so as economists. They are performing as hack propagandists. When "more doctors smoke Camels than any other cigarette," they are not offering a medical opinion.

Muzzling Dissent

"People everywhere confuse what they read in newspapers with news." -- A. J. "Joe" Liebling

Two somber thoughts. First, economics is not only not a science; it is not even a scholarly discipline. It is a subsection of journalism. There is the style section, the sports section, the front pages and economics. The academic jargon mills with their fancy maths are there solely to lend a cachet of prestige to the front line hacks. Case in point: Henry Hazlitt.

Second, the function of a "free press" in an oligarchy is the muzzling of dissent. As Liebling also wrote, "freedom of the press is guaranteed only to those who own one." The most effective way to muzzle dissent is to simply drown it out. That way you get to suppress speech in the name of free speech. Who could object to free speech? Those totalitarians! It's no coincidence that American fascists in the 1930s called themselves "Liberty Lobby."

Connecting the dots (and with one eye on the unexpurgated history of economic thought) the real purpose of economics today is not to foster understanding of how the economy works but to confound and marginalize those who understand even a bit of how it works.

All the flap about the "crisis of economics" and its inability to predict the great recession is so much bunk. Economics is performing exactly as it is supposed to, thank you very much.


Postscript: Having mentioned both Henry Hazlitt and Joe Liebling in one post, I started wondering if they ever crossed paths. Google Scholar produces one item that mentions both of them, a 2006 article in the Canadian Journal of Communications, "'Labor's Monkey Wrench': Newsweekly Coverage of the 1962-63 New York Newspaper Strike."

Viral Gyro Spiral

"We need campaign finance reform. We do not need 'heroes' who take meaningless flights of fancy." -- Marsha Mercer, Richmond Times-Dispatch

Have you ever wondered what politicians do with all that campaign finance money? They don't keep it (or at least not most of it). They spend it. On campaigning. A lot of it on advertising. Which means buying time and space in the media. Including the Richmond Times-Dispatch.

That media is not going to bite the hand that feeds it, is it? So, it's a bit rich when a columnist scolds a citizen for taking a "meaningless flight of fancy." What would Marsha Mercer do?

Labelling Doug Hughes's gyrocopter flight "meaningless" is what Mercer did. So we don't really need to ask what she "would" do. The job of the media is to spin and frame dissent as either trivial or terroristic. In an oligarchy, all dissent is either trivial or it is terror. Thus, by definition, no dissent can be "meaningful" in the sense of being both effectual and legitimate.

This is precisely the eye of the needle that Hughes threaded with his marvelous stunt. Superficially, it is about oligarchy and corruption of democracy by big money. But more profoundly -- and metaphorically -- it is about the hermetically-sealed "closed air space" over Washington. D.C. In his letter to all 535 members of Congress, Hughes quoted John Kerry on the corrosion of money in politics and it's contribution to "the justifiable anger of the American people. They know it. They know we know it. And yet nothing happens."

Kerry went on to point out how the corruption of money in politics "muzzles more Americans than it empowers." How does it do this? Well, for one, those same media outlets that profit from the spending of that corrupting money to buy advertising space also get to pass judgment on the wisdom or folly of dissenting speech: "Sit down, sit down, sit down, sit down! Sit down, you're rocking the boat!"

We need a lot more than campaign finance reform. We do not need minders and muzzlers from the media to tell us what is "meaningful" and what is not.

Are There Any True Laws, Especially Economic Ones?

This is triggered by the recent post by Tyler Cowen and some followups by others.  In it Tyler posits three laws: 1) There is something wrong with everything (no slam dunks, and one only understands something if one knows its flaws), 2) There is a literature on everything, and 3) All propositions about real interest rates are wrong.  The first clearly contradicts itself, and while most laws may be limited or not universally true, some are truer than others, e.g., round earth model closer to reality than flat earth one.  The second is clearly false as some ideas have never even been verbally expressed by anybody, although the real point of this is probably to warn that if somebody thinks they know the full literature on something that has a literature, they probably do not.  The final one is probably empirically correct, although properly stated theoretical models contingent on unrealistic assumptions may be correct if their unrealistic assumptions hold.  More generally, Tyler warns that we should all be wary of thinking we know too much, which is clearly correct.

In a followup he links to Arnold Kling who poses three laws due to his poli sci prof dad, Merle Kling: 1) Sometimes it's this way, and sometimes it's that way (I can think of some things that are pretty much always one way), 2) The data are insufficient (often the case, but maybe not always), and 3) The methodology is flawed (see 2).  He calls these "iron laws of social science," but they do not look  any more ironclad than Ricardo's Iron Law of Wages, which depends on some assumptions holding that are in fact not true, such as there being no technological change.  More like silly putty laws.

OK, so are there really any fully true laws?  Even beyond economics, most "laws" depend on certain assumptions holding for them to hold as well.  In some areas, this is not such a big deal, and thus in chemistry, a lot of its laws hold pretty widely.  Physics gets a bit iffier, with the good old law of gravity the classic example.  Sure enough the equation explains rates of acceleration in a vacuum, but outside of a vacuum, well we even see some things moving away from each other, such as a helium balloon rising away from the earth.  Nevertheless, in many hard sciences it is a lot easier to figure out when the necessary assumptions are holding and when they are not so that one can figure out when the supposed laws will apply to the real world or not, even if those assumptions do not always hold everywhere and at all times (and some physics laws hold simply everywhere at all times, as best we know).

When we get to economics, it looks to me that Tyler's first law holds pretty well.  Most economics laws do not hold universally.  Demand curves do not always slope downwards, even though Misesian a prioristic praxeologists insist so, and socially necessary labor time does not always determine values that equal "natural" long-run prices, even though fundamentalist Marxians might believe so.  The basis "law" of supply and demand, although useful for understanding many real world markets,  does not always hold in its standard formulation for a long list of reasons.  And most of the laws used to study or explicate macroeconomics, such as claims about real interest rates, are by and large wrong or only true in limited cases.

Given all  that, I shall note one economics law that I so far  do not know of any exceptions to.  That is the law of diminishing returns, or diminishing marginal productivity.  Keep in mind that its formulation says that "eventually" marginal product of an input will decline, not that it is always declining, and for many agricultural activities many inputs have increasing marginal productivity for awhile.  If anybody can think of a real world exception to this law, I would warmly welcome learning of it, but so far, it seems to hold universally.

Barkley Rosser

Stamp Out Oligarchy

Never Mind the Bollocks. Here's the Gyro