More on Units and the Economic Cost of Spending Cuts

There is a new estimate of the effect of $ 60 billion spending cut on GDP and employment. Since this estimate was made by brilliant economist* Ben Bernanke aided by the staff of the Federal Reserve Board, it will get a lot of attention.

Bernanke said that a $60 billion cut along the lines being pursued by Republicans in the House of Representatives would likely trim growth by around two-tenths of a percentage point in the first year and one-tenth in the next year.

“That would translate into a couple of hundred thousand jobs. So it’s not trivial,” he said in response to questions from members of the House Financial Services Committee.

This sure seems to be completely different from Mark Zandi’s estimate of 700,000 jobs. I think there is some confusion about units of measure and, in particular about the unit the “job.”

How can that be ? Well the effect of a policy shock changes over time and so one can discuss the effect on person-years of unemployment. One can also discuss the maximum effect on unemployment, which, in practice means the effect measured in the month with the largest effect.

Bernanke explained his calculation. He calculated the effect on yearly GDP in 2012 then applied Okun’s law. Thus he calculated the effect on average employment in 2012. His estimate of job-years lost is around 200,000 in 2012 after 133,000 in 2011 and presumably some in 2013. There is no way to calculate the largest monthly difference between employment given Obama’s budget proposal and employment given the House Republicans budget from yearly growth rates.

I’m sure Zandi is talking about the largest monthly difference which I would guess he forecasts for late 2011 or early 2012.

I can do an Okun’s law calculation for Phillips et al. (the Goldman Sachs team). They predict that the cuts will cause third quarter GDP to be 0.75% lower. By Okuns law, that corresponds to roughly 500,000 fewer jobs (three eighth’s of one percent of the labor force).

They forecast that second quarter GDP will be 0.375% lower. That means that they forecast that growth from fiscal year 2010 to fiscal year 2011 will be reduced by
9/32 percent, that is roughly 0.3%. This is a larger effect than the Fed’s estimated effect on growth (I can’t tell how much larger as Phillips et al didn’t report a forecast for the 4th quarter). But 0.3% is 0.3%. I describe Phillips et al’s estimate as implying the loss of 500,000 job-quarters in the quarter of maximum impact. Using the same Okun’s law and the same Phillips et al forecast, Bernanke would say 200,000 job-years in fiscal 2011. The 2.5 fold difference is a matter of units of measure.

* This is not at all ironic. I think he is brilliant. Also and much more important, he is reality based. There are smart mathematicians who present themselves as economists but really study formal systems. Bernanke has brilliant thoughts about what really happened in the real world *and* he confronts them with the data.