The CEA Before the 1966 Credit Crunch v. the CEA in 2003

Greg Mankiw reminds us of what he said back on September 15, 2003 and adds:

Looking back after four years, I think this holds up pretty well.

After arguing that the 2001 and 2003 tax cuts had desirable short-term Keynesian aggregate demand effects, the speech goes into the alleged long-run supply-side benefits. I was scratching my head thinking “crowding-out” and lo and behold we finally got to see this wisdom:

Of course, the expansionary effects of the tax cuts will be offset to some degree by the effects of the budget deficits that arise from lower revenues. Deficits can raise interest rates and crowd out of investment, although I should note that the magnitude of this effect is much debated in the economics literature. The main problem now facing the U.S. economy is not high interest rates, but at some point continued deficits would matter and could impede growth.

If we go back to what the Federal Reserve was thinking by late 2003, they were already increasing interest rates. Why? Because they thought we were about to have a revival of investment demand with or without the 2003 tax cuts. We were also seeing an increase in defense spending from the Iraq debacle and were also seeing a push for a very expensive prescription drug benefit. In a word, the fiscal triple whammy that so concerned the CEA back in late 1965. Then it was the 1964 tax cut, Vietnam, and the Great Society. The CEA warned President Johnson that if fiscal stimulus was not reversed, the Federal Reserve would likely raise interest rates and crowd-out investment. But Dr. Mankiw continued in his speech with:

This is why, as the President has said, spending restraint is so vital. The Administration would prefer not to have deficits, but deficit reduction is only one of many goals. Reversing the tax cuts today, as some have suggested, would depress growth and job creation. This is a matter of priorities: In the face of a shrinking or barely growing economy, an investment slowdown, and continued job losses, the President made growth and jobs his number one economic priority. There are others who think he should make deficit management the top priority – but the Administration does not share that point of view. Deficits are worrisome, but not as worrisome as an economy that is not growing and is rapidly shedding jobs. It is also important to be aware of how these deficits arose. About half of the change in the fiscal outlook since the President took office is attributable to the weak economy, including the stock market. About a quarter is due to higher expenditures, mainly on homeland security and defense. The last quarter is due to reduced revenue from the tax cuts. And these estimates are based on static scoring, so they surely overstate the role of the tax cuts.

This sounded more like drinking from the Kool Aid than stern advice to a President who seemed hell bent on fiscal irresponsibility. In his own words, Greg Mankiw unwittingly admits that the fiscal advice in 2003 was not on par with the fiscal advice offered to President Johnson in late 1965. Of course, that advice went largely unheeded back in the late 1960’s.