Fiscal Policies That Hubbard & Mankiw Probably Did Not Endorse

Peronet Despeignes’s interview with Greg Mankiw was noted by Mark Thoma and Tyler Cowen and was critiqued in part by Brad DeLong. I wish to take on a couple of comments regarding fiscal policy. The first relates to:

The policy process worked extremely well. It’s not like one person sits there—like Karl Rove sits off all by himself making economic policy, or Dick Cheney sits all by himself making economic policy … Karl Rove is a very reasonable guy. I was absolutely delighted that he got the job as deputy chief of staff. He knows his stuff. Some political folks see policy as a way of getting political things accomplished. That’s not Karl Rove. He’s motivated a lot by good policy … I didn’t disagree with the thrust of fiscal policy. It’s a textbook prescription that it’s an appropriate time to run budget deficits in times of war and recession. President Bush inherited the conditions that were driving us into a recession and the war on terror, so I think running a deficit was an appropriate time to run, so I thought running a budget deficit over the past couple years was a very reasonable policy response.

I’m find it hard to accept the notion that any bright economist – whether Glenn Hubbard or Greg Mankiw – agreed with the mess known as Bush’s fiscal policy. Let’s start with the 2001 tax cut, which was originally designed by Lawrence Lindsey in 1999 when the economy was near full employment. Lindsey may have claimed it was “perfectly timed” in 2001 but it was poorly designed regardless of what the policy objective might have been. Lindsey claimed the tax “cuts” – which were really tax deferrals given there was no offsetting reduction in government spending – were designed to make the tax code more equitable. Now if young blue collar workers pay too little in taxes with rich elderly types paying too much, I can see this argument. While Bush was claiming we should “give people their money back” so they can consume more – Hubbard’s rational for fiscal policy reform has always been to increase savings (less consumption). But we should concede Mankiw’s point that we needed some stimulus in 2001, which is where the poorly designed part comes in. Consider Mankiw’s Savers-Spenders Model of Fiscal Policy where lower income households are liquidity constrained. If aggregate demand stimulus was the goal, passing delayed tax rate cuts focused on high income individuals was precisely the wrong approach.

By October 2001, the Senate moderates in both parties decided the right strategy would be to have short-term fiscal stimulus with long-term fiscal restraint, which is often referred to as Rubinomics. This strategy would both allow for both a more effective aggregate demand stimulus and more long-term savings and investment, which would have brought together Mankiw’s goal of restoring full employment and Hubbard’s goal of higher long-term growth. Alas – the political operatives in the White House made sure this sensible agenda of the Senate moderates would not be enacted.

In fact, none of Bush’s fiscal agenda makes economic sense unless one seriously believes that this Administration is pursuing a small government strategy, which would require massive reductions in government spending. Mankiw continues:

If you look at discretionary spending, you see very significant spending restraint. But I think the issue longer term, over a five-, ten- or 20-year horizon, the big issue is not discretionary spending, but entitlements.

I’m sorry but I see not only defense spending rising but also increases in Federal nondefense spending. I do agree that the projected rise in entitlement spending is a serious issue, but then part of this projected increase comes from the oversized prescription drug benefit that the White House pushed through Congress.

Let’s recall the silly reason why Stephen Moore opposed Mankiw being appointed to the CEA:

Mankiw refers to Ronald Reagan’s supply-side advisers as “charlatans and cranks.”

Mankiw’s criticism of Reagan’s fiscal irresponsibility was first-rate. Yet, he cannot bring himself to do the same in regards George W. Bush’s fiscal irresponsibility. The only way that the CEA would have agreed to Bush’s fiscal policy would have been for it to be staffed by Lawrence Kudlow, Donald Luskin, and Tom Nugent. Bush, however, staffed the CEA with some very talented economists – but alas apparently refused to listen to their wise counsel.