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CBO Letter to Rep. Ryan re Stimulus Debt Service

by Bruce Webb
Reader Movie Guy suggests that the following letter and table merit some discussion. It seems to speak for itself but the whole thing is short enough simply to post (I deleted some returns and added some commas to save space, the original PDF is here CBO Letter to Rep. Ryan). Please add any contributions in comments.

Honorable Paul Ryan, Ranking Member, Committee on the Budget, U.S. House of Representatives

Dear Congressman:

As you requested, the Congressional Budget Office has estimated the costs of additional debt service that would result from enacting H.R. 1, the American Recovery and Reinvestment Act of 2009. Such costs are not included in CBO’s cost estimates for individual pieces of legislation and are not counted for Congressional scorekeeping purposes for such legislation.

Under CBO’s current economic assumptions and assuming that none of the direct budgetary effects of H.R. 1 are offset by future legislation, CBO estimates that the government’s interest costs would increase by $0.7 billion in fiscal year 2009 and by a total of $347 billion over the 2009-2019 period (see enclosed table).

If you would like any additional information, we would be happy to
provide it. The CBO staff contact is (redacted).

Sincerely, Douglas W. Elmendorf, Director

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WHITE HOUSE Communications:

reader Movie Guy

WHITE HOUSE Communications:

White House Press Pool Report
No pool reports filed yet.

EXECUTIVE ORDERS and PRESIDENTIAL MEMORANDA
The White House

President Obama delivers Your Weekly Address
The White House
Saturday, January 24th, 2009 at 5:55 am

MEMORANDUM FOR
THE SECRETARY OF STATE
THE ADMINISTRATOR OF THE UNITED STATES AGENCY FOR INTERNATIONAL DEVELOPMENT
SUBJECT: Mexico City Policy and Assistance for Voluntary Population Planning
BARACK OBAMA
THE WHITE HOUSE, January 23, 2009

Statement released after the President rescinds “Mexico City Policy”
The White House
Saturday, January 24th, 2009 at 10:12 am

—-

In The News:

Face The Nation: VP Biden (including full transcript)
Jan. 25, 2009

Obama’s Order Is Likely to Tighten Auto Standards
January 25, 2009
NYT and WAPO

Package questioned – stimulus or wasteful?
January 25, 2009

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Comment on Menzie Chinn

by Robert

Menzie Chinn provides an excellent summary of arguments that a fiscal stimulus will have no effect on GNP. He charitably doesn’t mention the deduction from an accounting identity. I can’t resist arguing against the arguments which he lists.
Click the link to find the arguments.

Excellent summary. I think that there is one important practical observation which might be added. Cases 2 and 3 assume non-accommodating monetary policy. At the moment this is very unrealistic. The FED is clearly pedal to the metal. An increase of safe short term nominal interest rates would be countered by the FED. I don’t see how a fiscal stimulus can reduce expected inflation so I don’t see how it could cause increased real interest rates either.

Case 4 implies that a fiscal stimulus would make things worse (since they are assumed to be perfect now). However, it is just not true that it would have 0 effect on output. In particular increased Government consumption would crowd out consumption for fixed labor supply. This should cause increased labor supply. Case 4 requires market clearing *and* exogenous labor supply. It is not consistent with real business cycle theory in which labor supply is endogenous. The model with market clearing and fixed labor supply is presented in textbooks just as a step towards a model with unemployment or a model with elastic labor supply — no one takes it seriously as a model of the business cycle.

Again in case 5, if there is Ricardian equivalence tax cuts have no effect on GNP but increased G can have an effect on GNP by crowding out private consumption and increasing labor supply. This can cause GNP to increase even if there is unemployment if matching of the unemployed and vacant jobs is not perfectly efficient which it isn’t.

update: Ooops silly me. Case 5 is plainly nonsense as explained by PGL here.

Suppose we decide to have an additional $100 billion in public investment in 2009. In Ricardo’s example, permanent taxes will increase by $5 billion per year which would have a very modest offsetting reduction in consumption. So if government purchases rise by $100 billion and consumption falls by $5 billion, then isn’t the direct impact on aggregate demand closer to $95 billion for the year rather than zero?

PGL links to Kevin Quinn who noted the error in the Wikipedia

I vaguely recalled that, while Ricardian equivalence implies that tax cuts do not stimulate GNP, even if there is Ricardian equivalence increased Government spending does cause increased GDP. I also recalled that Paul Krugman presented a model of optimal stimulus when in a liquidity trap in which Ricardian equivalence holds. However, my case above against case 5 is totally feeble compared to PGL’s simple obvious point that the debt built up by increased government spending would be counted by a rational forward looking representative consumer by subtracting it from her wealth, a stock, while the spending is a flow. Under standard assumptions this rational representative consumer typically spends around 5% of her total wealth per year (equal to the rate of time preference) so the stimulus is 95% as effective as it would be if people ignored their share of the national debt. The timing of taxes doesn’t matter to a rational representative consumer, so this is true whether or not the spending is deficit financed or tax financed. Thanks PGL.

Quinn also made a good point in a comment on PGL’s post

kevin quinn said…
Further, suppose it’s not for war but for public investment with a greater rate of return than 5%. Then our permanent income is higher, so consumption will increase along with G!

Indeed. PGL’s calculation assumes that government spending is pure waste. The cost to taxpayer consumers will be lower (and may be negative) if the government spending is productive investment, like, you know infrastructure.

Thanks Kevin Quinn too.

So really the cases are down to case 1 and the question is “is the velocity of money constant ?”.
All empirical estimates say no.

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Piling on Cochrane

by Robert

I’d say that Cochrane’s pure quantity theory of money argument against the stimulus is not nonsense like Fama’s effort to learn about the world from an accounting identity. This means I disagree with Krugman who focuses on the word “accounting” in Cochrane’s post.

I comment on a diatribe by Brad DeLong which has links to Cochrane and Krugman

I’d note that there have been many attempts to define and measure money and all show variable velocity which increases when nominal interest rates are high.

Sitting on money is not pathological. In the real world we can’t spend money instantly (in which case the velocity would be infinite).

Also he is wrong about “printing money”. Liquid assets of the US gov are not included in any estimate of the stock of money- If M1, M2 etc stay the same and they increase then, according to Cochrane’s unique personal definition, the money supply will have been increased.

I wonder what Friedman would think of the fact that a prominent prof at U Chicago doesn’t know the definition of M1.

More importantly money holdings by firms (and the gov if you count them) are insignificant compared to money holdings by households. The correct quantity variable for money demand estimates is consumption not GNP, because almost no money is used to lubricate investment or government consumption. This was proven by Mankiw and Summers in 1987. Here is a link to SSRN where you have to pay. Don’t pay for it, but if you do get the WP or the published version in the Journal of Money Credit and Banking, please read the acknowledgments.

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Commenting on Krugman

by Robert

Krugman is back to arguing that this recession will be followed by a long period of slack, that is low employment growth as were the last two and that therefore the standard argument in, for example, his textbook against fiscal stimulus and especially against spending as a stimulus is not convincing in this case.

The key paragraph is

So what is the right criterion? Actually, I think it’s quite straightforward. The reason we’re talking about fiscal policy is the fact that monetary policy is up against the zero lower bound. Stimulus will still be valuable as long as we’re still up against that bound — which is likely to be the case for a long time.

I quibble (addressing Prof Krugman in the second person something which I have never done in real life).

I would like to add one tiny comment on your excellent argument. You seem to be asserting that the key criterion is that the save short term nominal interest rate is zero. In fact you are also assuming that Greenspan knew what he was doing and that Bernanke does too, that is, that interest rates should be at the zero bound because inflation is not a risk (quite the contrary) so more stimulus is needed.

A Fed board along the lines of the Reichsbank 1918-1923 might very well keep nominal interest rates zero during a hyperinflation (they kept the discount rate 3% per year when the inflation rate was 50% per month and uhm rationed loans a bit).

There was a comment above by D. Sean who asks if the Fed kept interest rates high (sic meaning low) in 91 because it didn’t know the recession was over. A good question, but I think the answer is that the FED has excellent information and can detect an upturn long before the NBER business cycle timing committee makes a final irreversible decision.

The point is that you are assuming that Bernanke will keep interest rate at zero *and* that he will be wise to do so.

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Background on "fresh water" and "salt water" macroeconomics

by Robert

Will Wilkinson asks what’s with the economics profession.

A bit more on the public relations quandary the economics profession ought to be in, if it isn’t already…

When I see DeLong more or less indiscriminately trashing everyone at Chicago, or Krugman trashing Barro, etc., what doesn’t arise in my mind is a sense that some of these guys really know what they’re talking about while some of them are idiots. What arises in my mind is the strong suspicion that economic theory, as it is practiced and taught at the world’s leading institutions, is so far from consensus on certain fundamental questions that it is basically useless for adjudicating many profoundly important debates about economic policy. One implication of this is that it is wrong to extend to economists who advise policymakers, or become policymakers themselves, the respect we rightly extend to the practitioners of mature sciences. There is a reason extremely smart economists are out there playing reputation games instead of trying to settle the matter by doing better science. The reason is that, on the questions that are provoking intramural trashtalk, there is no science.

Sadly, there is no one better to listen to.

Now before going on I note that Wilkinson does not address the merits of DeLong’s criticisms or Krugman’s. He uses a words to suggest that they are writing unprofessionally but he doesn’t present a counter argument to their claims. I have quoted his full post. Nothing on the merits.

Instead he asks if disagreements between economists are so fundamental that there is no professional consensus useful to non economists. My brief answer is “yes.” A longer answer after the jump.

Update: Over at Kling’s blog commenter Bill Woolsey hits the nail on the head.

Perhaps part of the problem we face in macroeconomics today is that a substantial part of the “macro” wing of free market economists really think that new classical macroeconomics is “true” because simple and formalistically complete models fit their notion of what is scientific.

After the jump you can read my verbose effort to say that.

By the way, Kling’s willingness to criticize the arguments others present to support policy positions with which he agrees is really admirable.

It is like Ricardian equivalence. Because the model people (person) rationally saves to pay future taxes, we are supposed to assume this has a connection to reality?

Arnold Kling has already attempted to explain things to Wilkinson. He obtained a “department of huh?” from Brad DeLong and, for what it’s worth, two extremely intemporate comments from me (one was blocked as suspected spam because I provided to many links to support my claims which suggests something about the intellectual seriousness of comment threads at at least one blog).

While I claim that Kling’s take on the stimulus debate is absolutely inconsistent with facts in the public record which I found with a few minutes of googling, I share his general view on the divisions in the profession. He notes that there is more than one fundamental gulf which means that there isn’t a consensus among economists which would enable the few non economists who respect us to take our advice. I will mention three more just because I want to consider more economists than those discussed by Wilkensen and Kling and not because I think Kling left out anything relevant to his post

Kling discusses the policy advice of macroeconomists (and Fama). Not all economists are macroeconomists who think that it is there job to offer policy advice. He notes two divisioins left and right and fresh water and salt water.

Left and right correspond fairly closely to libertarian vs egalitarian in the US political spectrum, that is, closely to Democratic vs Republican positions on economics (except that there are leading economists well to the left of the Democratic party and well to right of all but the left fringe of the Republican party). It is a fact that, except for general support for free international trade, the range of views of economists is similar to the range of views of congressmen but somewhat broader. This is a wide enough ideological range that the methods of verification used by economists are absolutely unable to force economists on left and right to admit that economists on right and left have a point.

In the field of macroeconomics there is a much deeper division between macroeconomics as practiced at universities closer to the great lakes than to an Ocean (Fresh water economics) and that practiced at universities closer to Oceans (Salt water economics). The geography has shifted some as Fresh water economics has been exported. I’d consider Professor Robert Barro at Harvard to be brackish (with, he reports, noticed salty contamination in the first 6 months after he moved from U. Rochester) and the economics department at the University of Pompeu Fabra (in Barcelona) seems to be distilled. It is a little difficult to explain the disagreement to non economists. Frankly, I think this is because non-economists have difficulty believing that any sane person would take ffresh water economics seriously.

Roughly Fresh water economists consider general equilibrium models with complete markets and symmetric information to be decent approximations to reality. Unless they are specifically studying bounded rationality they assume rational expectations, that everyone knows and has always known every conceivable conditional probability. I’ve only met one economists who claims to believe that people actually do have rational expectations (and I suspect he was joking). However, the fresh water view is that it usually must be assumed that people have rational expectations.

Over near the Great Lakes there is considerable investigation of models in which the market outcome is Pareto efficient, that is, it is asserted that recessions are optimal and that, if they could be prevented, it would be a mistake to prevent them.

Salt water macroeconomics is basically everything else with huge differences between people who attempt to conduct useful empirical research without using formal economic theory and people who note the fundamental theoretical importance of incomplete markets and of asymmetric information and of imperfect competition (as in everything you think you know about general equilibrium theory is known to be false if markets are incomplete or there is asymmetric information or there is imperfect competition – Market outcomes are generically constrained Pareto inefficient which means that everyone can be made better off by regulations imposed by regulators who don’t know anything not known to market participants who also just restrict economic activity and don’t introduce innovations like, say, unemployment insurance).

Leading fresh water macroeconomists include Robert Lucas, Ed Prescott Thomas Sargent, Lars Hansen, John Cochrane, Larry Jones, Robert Barro (mostly), and Kevin Murphy (usually). Leading salt water economists include Paul Samuelson, Edmund Malinvaud, Jacques Dreze, Joseph Stiglitz, Robert Solow, Paul Krugman, Andrei Shliefer, Olivier Blanchard, George Akerlof, Robert Hall, Ben Bernankle, N. Gregory Mankiw, Christina Romer, David Romer and, and Lawrence Summers. Brad DeLong is also a salt water economist and he is very very smart, but last I knew, he was a little too far out there to be really a member of the economists club. I can’t classify Paul Romer.

Notably all of the above have made important contributions to fields other than macroeconomics.

In the US there is a strong correlation between Fresh and Salt and Right and Left. The correlation is not perfect: I understand that Hansen and Sargent are politically left of center. Hall is far right politically, Mankiw is right of center. and I must admit that I have no clue about Bernanke (who I have never actually, you know, seen in the flesh).

An important discrimminant is opinions of John Maynard Keynes. Fresh water macroeconomists generally seem to think that he was not a competent economist. Salt water macroeconomists claim (often implausibly) to be in some way his intellectual followers. Barro for example clearly doesn’t remember what is written in “The General Theory of Employment Interest and Money.” Mankiw, in contrast, advised the students in his macro class (including me) to read it again and again searching for insights.

Interestingly, the fresh water macroeconomists are certain that salt water macro is discredited along the lines of the Ptolomaic model or the Phlogiston hypothesis. For a while they called their models “Modern Business Cycle Theory” stating that all incompatible models were obsolete. In the current debate many have considered it sufficient to say that arguments for the stimulus are nonsense (e.g. Cochrane). The surprisingly low quality of contributions to the debate from the vicinity of Great Lakes has a lot to do with the fact that Fresh Water macroeconomists haven’t thought about fiscal stimulus in decades and sincerely believe that it is an obviously invalid proposal so obvious arguments against it might be valid.

Even more interesting, Fresh water macroeconomists do not claim that their models have not been refuted by the data. Rather they note that all models are, by definition, false. They do test hypotheses from time to time, but don’t explain what the point is. As far as I can understand, they claim that a model *can* be both false and useful and, therefore, their models *are* useful.

I understand that in the 70s and, maybe, the early 80s there was a heated debate between Fresh Water and Salt water macroecnomists. Now, it seems to me that there is a truce of sorts where each school of thought ignores the other – that macroeconomists have specialized not in the questions that they ask but in the answers.

I think that this is a very bad situation. Anyone can see that, when top macroeconomists are asked for policy advice, some support each of the different proposals which are under consideration.

Frankly, this truce seems to me to be unilateral. Many salt water economists claim (in public) to respect the contribution of fresh water economists. I know of no fresh water economist who has expressed anything but contempt for the contributions of salt water economists to the stimulus debate and I haven’t heard one word of praise of a Salt Water economist from a Fresh water macroeconomist other than Arrow, Samuelson or Solow. I added the phrase “in public” because I clearly remember one of the salt water economists on my list refer to the fresh water economists as “the crazies”.

update: The truce is over. There have been continual cease fire offensives violations, but the shrill blitzkreig is here.

As far as I can tell, fresh water economists have some respect for some thinkers other than fresh water economists. I think they have rather a favorable view of mathematicians and Physicists. I think it would be useful of mathematicians and physicists to look into fresh water macro and express an opinion. On the other hand, in principle they have great respect for general equilibrium theory, but they don’t listen to general equilibrium theorists at all. Top general equilibrium theorists are all at least left of center politically, the closest David Cass could come to naming an exception is Ed Prescott who, he said, uses general equilibrium theory and studies examples (snort).

Finally I have a view of how people can devote so much effort to working out the implications of assumptions which almost no ordinary people would find other than nonsensical if they understood them. Fresh water economics uses difficult mathematical tools. Students in fresh water graduate programs have to learn a huge amount of math very fast. It is not possible to do so if one doesn’t set aside all doubt as to the validity of the approach. Once the huge investment has been made it is psychologically difficult to decide that it was wasted. Hence the school gets new disciples by forcing students to follow extremely difficult courses. Last I hear very few graduate students at U Minnesota came from the USA. Undergrads over there know what the program is like. If my information is not out of date, innocents from abroad are the new blood of fresh water economics.

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New Deal –Objective Research?

By Spencer

I just read an interesting article on the New Deal by Alan Brinkley in the New Republic titled No Deal, Learning From FDR’s Mistakes”.

The first two paragraphs are quote:

Does the New Deal provide a useful model for fixing our own troubled economy? In many respects, yes. The frenzy of activity and innovation that marked Franklin Roosevelt’s initial months in office–a welcome contrast to the seeming paralysis of the discredited Hoover regime–helped first and foremost to lessen the panic that had gripped the nation. And, during the prewar years of his presidency, Roosevelt’s actions produced an unprecedented array of tangible achievements as well. He moved quickly and effectively to address a wave of bank failures that threatened to shut down the financial system. He created the Securities and Exchange Commission, which helped make the beleaguered stock market more transparent and thus more trustworthy. He responded to out-of-control unemployment by launching the Civil Works Administration, the Public Works Administration, and the Works Progress Administration, which created jobs for millions of the unemployed. He passed the Social Security Act, which over time provided support to the jobless, the indigent, and the elderly–and the Wagner Act, which eventually raised wages by giving unions the right to bargain collectively with employers. He signed the Fair Labor Standards Act, which created the minimum wage and the 40-hour workweek.

Yet, despite these extraordinary achievements, Roosevelt’s initiatives did not, in the end, lift the country out of the Great Depression. At no time in the first eight years of the New Deal did unemployment drop below 15 percent. At no time did economic activity reach levels comparable to those of a decade earlier; and, while there were periods when the economy seemed to be recovering, none of them lasted very long. And so this bold, active, and creative moment in our history proved to be a failure at its central task. Understanding what went wrong could help us avoid making the same mistakes today.

This second paragraph drove me up the wall. Every statement in it is incorrect.
(Explanation below the fold)

STATEMENT 1:At no time in the first eight years of the New Deal did unemployment drop below 15 percent.

UNEMPLOYMENT RATE
…………OFFICIAL………. ADJUSTED

1933……. 25.2……………. 20.9
1934……. 22.0 ………….. 16.2
1935…… 20.3 …………… 14.2
1936…… 17.0 …………… 10.0
1937…… 14.3………………. 9.2
1938…… 19.1……………. 12.5
1939…… 17.2……………. 11.3

Source :BLS

The adjusted rate incorporates Works Programs Employment. If you use this data in every year from 1935 on the unemployment rate was below 15%. But even using the official data it was 14.3% in 1937, directly contradicting Brinkley’s statement.

STATEMENT 2: At no time did economic activity reach levels comparable to those of a decade earlier;

REAL GDP
…………..(BILLION……………..(BILLION
YEAR ……2000 $)….. YEAR…… 2000)……… %
1925…… $748.60……. 1935…… $766.90……. 2.4
1926…… $793.90……. 1936…… $866.60……. 9.2
1927…… $798.40……. 1937……. $911.10…… 14.1
1928…… $812.60……. 1938……. $879.70……. 8.3
1929…… $865.20……. 1939……. $950.70……. 9.9
1930…… $790.70……. 1940…… $1,034……… 30.8

Source: BEA

In 1935 real GDP was 2.4% larger than in 1925. As the table shows in every year after
1935 economic activity exceeded that of a decade earlier. Brinkley is completely wrong.

Note that in 1936 real GDP exceeded the previous peak of 1929. This is the official NBER definition of an economic recovery.

Statement 3: , while there were periods when the economy seemed to be recovering, none of them lasted very long.

According to the National Bureau of Economic Research (NBER)from 1854 to 1929 there were 17 economic cycles. In these 17 cycles the average peace time expansion lasted 24 months and the longest in the early 1880s lasted 36 months. The two longest expansions were of 46 months during the Civil War and 44 Months during WW I. The May 1933 to June 1938 expansion was 50 months and real GDP growth averaged 7.3%–the strongest four year growth since 1881. The 1933-37 expansion is the longest expansion on record until this time. It was more than double the average previous peacetime expansion and even exceeded the two long war time expansions. Again this is the exact opposite of what Brinkley stated.

Source: NBER.org

Alan Brinkley is a world class, respected historian and The New Republic is not some “wingnut” publication. But how are you suppose to react when mainstream historians who are not particularly anti New Deal start off their article and analysis of the New Deal with such incorrect information? As soon as I read the second paragraph I was forced to conclude that Brinkley did not know what he was talking about and his judgment should not be trusted. What else is one to conclude?

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Another Reason to Avoid Handwringing Over the Stimulus Spending

Tom Bozzo

was just looking at this picture and thought it was worth sharing, a propos of recent postings on the prospective pace of stimulus expenditures:


(click to embiggen)

This shows subsequent revisions to the CBO’s real GDP forecasts. Barring an exceptionally rapid recovery, GDP looks to be materially below potential output in 2011 (i.e. 3 quarters of FY 2011 and 1 of FY 2012) and 2012. Not-so-near-term stimulus is thus defensible; the real question is whether the near-term package is enough.

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