"It's an Insult to Keynes"

Bruce Bartlett says temporary tax cuts may not have much of an impact on the economy:

Feel-Good Economics, by Bruce Bartlett, Commentary, WSJ: With remarkable speed, Congress, the White House, Republicans, Democrats and even the Federal Reserve have come to a consensus on the need for economic stimulus... It seems certain that the final stimulus package will contain a tax rebate.

The underlying theory for the rebate idea traces back to the British economist John Maynard Keynes. He believed that spending was the driving force in the economy. It didn't matter whether the spending was done by businesses on capital equipment, by governments on public works, or by consumers -- spending is spending in the Keynesian model, and all of it is stimulative. ...

In the 1960s and 1970s, this usually took the form of public works spending. But in 1974, the White House was keen on the idea of cutting taxes to stimulate private spending. Since it was feared that a permanent tax cut might be inflationary, President Gerald Ford and the Democratic Congress agreed on a one-shot tax rebate. It was thought that cash-strapped consumers would take their government checks and immediately run out and spend them... This would give the economy a Keynesian boost.

One dissenter was economist Milton Friedman. His research had led him to conclude that consumer spending was ... a function of ... "permanent income." ... Friedman predicted that the $100 to $200 checks disbursed ... in the spring of 1975 would have a minimal impact on spending, because they did not alter peoples' permanent income. Most likely, people would save the money or pay down debt, which is the same thing. ...

In 2001 ... Congress and the White House once again chose a one-shot tax rebate to deal with an economic slowdown in 2001.

To his credit, Treasury Secretary Paul O'Neill cautioned against the rebate. "I was here when we tried that in 1975, and it just didn't work," he said. "If we want to change consumption patterns, we need to make permanent changes in peoples' tax burdens." But President George W. Bush overruled his Treasury secretary and approved the rebate idea. Checks of $300 to $600 per taxpayer were sent out in the late summer. Contemporaneous polls by Gallup, Bloomberg and the University of Michigan all found that the vast bulk of consumers expected to save the money or use it to pay bills. Subsequent studies confirmed these forecasts.

In short, there is virtually no empirical evidence that tax rebates are an effective response to economic slowdowns. ... The main benefit of a tax rebate would seem to be political -- giving politicians a way of appearing to be doing something about the nation's economic problems...

A new rebate probably won't do much harm. But anyone who thinks it will prevent a recession -- if one is actually in the pipeline, which is not at all certain -- is dreaming. It's an insult to Keynes even to call a tax rebate Keynesian economics. It should be called "feel good economics" because its only real effect is to make politicians feel good about themselves and buy re-election with the public purse.

I talked about this in early December:

Marty Feldstein says it's time to use both monetary and fiscal policy to deal with the weakness in the economy ... How to Avert Recession, by Martin Feldstein, Commentary, WSJ ...

If we go the temporary fiscal policy stimulus route, which can occur through either an increase in government spending or a decrease in taxes, there is a reason to prefer increased spending. A tax cut creates an incentive for households to increase consumption, but there is no guarantee that they will, e.g. they could just retire debt instead. ... In addition, when the tax cut is temporary, as this one would be, the impact on consumption is generally lower than with a permanent change in taxes.

With government spending, however, the impact on aggregate demand is assured. A change in government spending impacts aggregate demand directly on a dollar for dollar basis so there is no uncertainty at all about whether or how much aggregate demand will increase with a change in fiscal policy. And, with all of our infrastructure needs, it's not as though we can't find places where government spending could increase output and employment and also improve our public capital (there are many other ways spending could help as well, infrastructure enhancement is not our only need).

So, I agree that we may need to try fiscal policy, but I don't see why temporary tax cuts should be preferred to temporary increases in spending. ...

Bartlett and others are trying to argue that the tax cuts must be permanent in order to be effective. But the effect of permanent tax cuts is not certain. First, tax cuts create an incentive to buy more goods and services, but as noted above, there's no guarantee that will happen, e.g. the money can be used to pay debts instead. Second, permanent is in the eye of the consumer. Politicians can tell people the tax cuts are permanent, but a permanent cut in taxes today today followed by a permanent increase in taxes  tomorrow back where they started is a temporary change. If people believe things will change in the future, or have uncertainties about future policy - and they will - then the permanence of the cut will be in doubt and it will be less effective. Third, permanent tax cuts are not a sustainable countercyclical policy. To be permanent, taxes can never be raised again once they are cut, so eventually, after a few cycles of tax cuts to combat weakness, taxes would be as low as they could go for even an absolute minimal level of government and further cuts will be impossible. Finally, and importantly, the tax cuts that do the most for economic growth in the long-run, the kinds of tax changes you want to make permanent, are very different from the tax policies that cause spending to go up quickly in the short-run to kick start the economy. We shouldn't confuse growth policy with stabilization policy, though some are trying as hard as they can to do just that, cause confusion about the two so they can get permanent tax cuts through using a potential recession as cover.

So permanent tax cuts have a better chance of having an impact on the economy than temporary tax cuts, but there is no certainty about it. Permanent tax cuts are not guaranteed to work. However, as noted above, government spending on public works projects or in other areas will have a predictable initial impact on aggregate demand, it does work. The problem, of course, is timeliness, both in getting spending proposals through congress and in getting the projects up and running quickly. But it's not an impossible task, and since employment effects can linger for some time after the onset of a recession, if some projects take a little more time to get started that isn't so bad. But stimulus is also needed quickly and one way to do that is to simply avoid closing down existing government expenditures at the state and local level. In recessions, state budgets come under pressure and money directed to states can help to avoid having projects discontinued at the state and local level when just the opposite is needed. There are other ways to quickly bolster spending as well, but it takes a congress as committed and amenable to government spending changes to stabilize the economy as this congress is to tax cuts. Given the opposition to using spending rather than tax cuts, it's probably a non-starter for this congress. But unwillingness is not the same as infeasibility.

So, if you must have tax rebates, remember that a tax rebate is just another name for a government transfer payment (e.g. you pay the government $1,000, it rebates or transfers $100 back to you). But tax rebates are not the only kind of transfer payment, and widely distributed tax rebates are not the best way of stimulating the economy. It is possible to get money into the hands of  people, people struggling due to the downturn, where we can be virtually certain that all of it will be spent on goods and services. And many of these programs are already in place, it's simply a matter of enhancing them. Making it easier for people to qualify for unemployment compensation, temporarily extending the time that benefits are paid, temporarily expanding eligibility for food stamps, there are all sorts of programs to get money into the hands of people who are likely to spend it immediately providing a boost to the economy.

There is, of course, one difference between transfer payments and tax rebates. A tax rebate of $100 goes to the person who paid the taxes. A transfer payment may be just that, a transfer from the person paying the taxes to the person receiving the government help. Never mind that it's easy to ensure that the transfer is from rich to poor, or that such transfers are a better means of stimulating the economy than across the board tax rebates, the mere fact that transfers exist is enough to bring opposition from conservatives and block any moves in this direction.

Update: Here's Paul Krugman with similar thoughts:

Stimulus issues, by Paul Krugman: The big problem with attempts to provide temporary economic stimulus is how to ensure that the money gets spent. As Milton Friedman pointed out 50 years ago, consumers tend to base their spending on “permanent income” — the income they expect to have over the long run — rather than their income in any given year. So an $800 check from the Treasury tends, other things equal, to be mostly saved rather than spent.

How does one get around this?

One answer is that not everyone bases spending on permanent income. In particular, people who don’t have a savings cushion and can’t borrow (or can only borrow at high credit-card rates) may be “liquidity constrained,” spending less than they’d like to given their permanent income. For example, a laid-off worker who expects to get another job eventually, but meanwhile is running low on savings, is very likely to spend an extra check.

Another answer is for the government to spend the money directly — or simply refrain from spending cuts that would otherwise happen. For example, state and local governments, which aren’t supposed to run deficits, may be forced to slash spending in a recession; aid to these governments can avert these spending cuts, which is a real plus for the economy.

All of this suggests that if you want a stimulus plan to actually affect demand, it should focus on people likely to be liquidity constrained and on sustaining government spending.

But — you knew this was coming, didn’t you? — it seems that the Bush administration wants to restrict the plan to income tax rebates. This means excluding the people most likely to be liquidity-constrained — because people having a bad year probably won’t owe income taxes that year — and shying away from any aid to direct government spending.

The point is that the debate over exactly how the $145 billion or whatever gets allocated is not, as some might think, a second-order issue. It’s probably at the heart of whether this plan has any real effect.

Comments

[Sam]

hmm, if citing Friedman to defend permanent tax cuts as a stimulus, or suggest that an increase in spending would be superior (as I believe it would), surely one should note that to spend is to tax as day follows night?

[Mark Thoma]

That doesn't have to be true. With Keynesian stabilization policy done according to the book, the budget is balanced over the business cycle. You borrow from the good times to enhance the bad times. This brings down the peak, and fills the trough, but it doesn't change the long-run budget situation. In the real world of politics other things might happen, but there's no necessity about it.

[lutton]

Your grandparents might have saved that money or paid down long-term debt (mortgage, etc).

Almost no one saves cash in hand today--just whatever retirement gets pulled directly from payroll--and I suspect that if people do pay off debt, it'll be credit card debt, which will likely just get spent again anyway.

[anne]

Well I have no problem with all those furry Friedmanites, since all the little dears have to do about not turning spending to taxing is to, like, make sure that we leave Iraq as General Raymond Odierno, having secretly become the next President, tells us we will be doing for years and years to come. We could though, so rally the Friedmanites.

[Cosi]

Mark,

I agree with most of your points and with your general argument(s), but just in fairness to Bruce Bartlett, are you sure he was arguing for permanent tax cuts for fiscal stimulus, as opposed to simply arguing against rebates?

As for stimulus, for whatever it's worth, I'd rather see management of the economic cycle left to the Fed (i.e., NO fiscal stimulus) except under clear, extraordinary circumstances that don't apply at this point. The Fed, as opposed to politicians, will base decisions on what to do and when mostly on economics rather than politics, and is therefore more likely to provide stimulus that is timely and efficient while also considering longer-term effects in a responsible manner. Would you agree?

[Cosi]

Mark,

I agree with most of your points and with your general argument(s), but just in fairness to Bruce Bartlett, are you sure he was arguing for permanent tax cuts for fiscal stimulus, as opposed to simply arguing against rebates?

As for stimulus, for whatever it's worth, I'd rather see management of the economic cycle left to the Fed (i.e., NO fiscal stimulus) except under clear, extraordinary circumstances that don't apply at this point. The Fed, as opposed to politicians, will base decisions on what to do and when mostly on economics rather than politics, and is therefore more likely to provide stimulus that is timely and efficient while also considering longer-term effects in a responsible manner. Would you agree?

[Do I Understand This Correctly?]

Foreign savers will no longer lend to citizens for consumption (by buying securitized mortgages and such), so the gov will temporarily borrow the money from foreign savers and give it to citizens to spend.

[anne]

Bruce Bartlett has only one thing ever in mind, making sure government revenues are so small that any needed domestic social program will come to seem impossible. Cut taxes enough so that a move to broaden health care protection even to needy children will seem impossible, let alone a move to universal health care. Cut taxes so that revenue sharing to reduce tuitions at public colleges and universities will seem impossible, along with all hard infrastructure needs. The idea is to destroy any vestige of the legacy of Franklin Roosevelt. So, make sure we have permanent tax cuts which will make raising taxes near impossible. This is simply compassionless conservatism. Yuck.

[barry payne - economist]

Duesenberry provided an alternative theory to Friedman to explain the short term rigidity of consumption indicated in the excerpt below - full article at the link.

http://www.nytimes.com/2005/06/09/business/09scene.html?_r=1&oref=slogin

The real surprise is that most academic economists under 50 have also never heard of Mr. Duesenberry.

This is puzzling because his theory of consumer behavior clearly outperforms the alternative theories that displaced it in the 1950's - a striking reversal of the usual pattern in which theories are displaced by alternatives that better explain the evidence. His disappearance from modern economics textbooks is an intriguing cautionary tale in the sociology of knowledge.

But it also has important practical implications. Unless we understand what drives consumption, which makes up two-thirds of total economic activity, we cannot predict how people will respond to policy changes like tax cuts or Social Security privatization.

Any successful consumption theory must accommodate three basic patterns: the rich save at higher rates than the poor; national savings rates remain roughly constant as income grows; and national consumption is more stable than national income over short periods.

The first two patterns appear contradictory: If the rich save at higher rates, savings rates should rise over time as everyone becomes richer. Yet this does not happen.

Mr. Duesenberry's explanation of the discrepancy is that poverty is relative. The poor save at lower rates, he argued, because the higher spending of others kindles aspirations they find difficult to meet. This difficulty persists no matter how much national income grows, and hence the failure of national savings rates to rise over time.

[Robinia]

Do I Understand This Correctly? that is an interesting question, indeed. Answer seems to be yes, and, yes, it looks pretty dumb.

The reference to Ford-- an era I suffered through-- reminds me much of those "WIN" ("Whip Inflation Now") buttons he popularized, that we used to turn upside down to read "NIM" ("No Immediate Miracles").

[ken melvin]

There was a time when extra money in consumers pockets meant they would buy clothes, refrigerators, TVs, cars, ... and in doing so create jobs for more workers who would buy more clothes, refrigerators, TVs, cars, ...,but that was a long time ago. Now, the clothes, TVs, refrigerators, and most of the cars are made overseas.

[save_the_rustbelt]

One of the more interesting topics I have taught and observed over the years is the psychology of budgeting and financial decision making.

Perhaps we need to consider the psychology of the economics here.

Perhaps doing something is better than doing nothing, more for psych reasons than pure economics.

Just wondering.

[Bruce Bartlett]

Just for the record, I was not trying to make an argument for permanent tax cuts, I was only trying to argue against rebates. If you check the record you will see that I made exactly the same argument in another WSJ article back in 2001, so I am being consistent. The point I made about the superiority of a permanent tax cut over a temporary one is simply what is reported in the literature. Go argue with Alan Blinder if you want to.

And lest anyone confuse me with Grover Norquist, I am also on record as saying that we must raise taxes fairly substantially in the near future. I have even said, specifically, that the United States should adopt a value-added tax. And in case anyone is interested, my position on this issue has made me unemployable by every right-of-center group in America, forcing me to make my living as a free-land writer. People like Anne, who criticizes me on multiple blogs, might keep that in mind the next time she reaches for her keyboard to write another attack on me.

[Voting With Their Feet]

STR..."Perhaps doing something is better than doing nothing, more for psych reasons than pure economics."

The market was rising before the plan was unveiled. The market started to drop as the President spoke. The market dropped when Ben started speaking the other day. The temporary patch does not seem to be viewed by the market as addressing the primary problem.

[Bill]

"Do I Understand This Correctly? says..." hits the nail on the head.

And if we spend the money on imports from China this stimulates the economy how??

Since the problem is centered on people not being able to stay current on their mortgages, isn't monetary policy the most direct route to providing relief in this case?

Bill

[anne]

Poor sweet mis-understood dear, who I obviously do not citicize on multiple blogs unless multiple means 2, though I should criticize more even thre. Me, I only ever make comments on Mark Thoma's or Brad DeLong's blogs. Nowhere, nohow elsewhere.

So the sweet misunderstood dear wishes to raise taxes fairly substantially in the near future, can we all repeat "value-added?" which is as self-defeating a suggestion as permanent tax cuts.

Nonetheless, I always wish everyone the finest of employment and I am truly sorry that Bruce Bartlett who is a splendid writer is not widely sought after.

[knzn]

One thing that Bartlett and others should consider is the role of liquidity constraints in the impact of temporary tax cuts. If people would prefer to borrow money but cannot do so at a reasonable interest rate, then a temporary tax cut is like the loan they had been wishing to have, and they will spend the money just as they would have spent the loan money. Under today's circumstances, with home equity credit suddenly tighter than it has been for years, it seems likely that more people than usual are liquidity constrained.

[anne]

Being nice just now I should add that Bruce Bartlett has opposed war in and occupation of Iraq for which I am truly grateful and for which alone intelligent conservatives should be continually seeking his advice and support and services.

[2slugbaits]

Mark,

Picking up on KNZN's point about liquidity constraints, there is a new paper over at NBER that argues against Friedman's Permanent Income Hypothesis (PIH). The paper specifically looked at the 2001 tax rebate and found that liquidity constrained families used the tax rebate in a way that was quite different from families who were not liquidity constrained. The new evidence undercuts much of the PIH.

[flow5]

Prorating the federal deficits over the entire spectrum of federal expenditures, it can be said that virtually all of the current deficits are attributable to defense spending, military and civil service pensions, interest on the debt, and welfare and unemployment benefits. Social security is not included in the above list since only a very small proportion of social security benefits are financed from nonsocial security taxes. From an economic standpoint, only interest is “untouchable”.

[robertdfeinman]

As usual large-scale economic policy ideas ignore the effects of actual people, I'm going to make the air conditioner analogy.

It's very hot out and so you go into an air conditioned space. You feel better. Eventually the heat wave breaks and you resume normal activities. Did the air conditioning change the weather? No. Did it help ride out the high temperatures? Yes.

Let's suppose that the current downturn is caused by some combination of financial mismanagement and rising oil prices (add your own additional causes, if you wish). The financial crisis will be resolved, probably within this year. The economy will adjust to the oil increase through some combination of improved efficiency and alterations in consumption patters. Even the wars may wind down.

When this happens the economy will pick up, perhaps not to a boom level, but something reasonable. What's wrong with supplying people with a bit of support in the interim? Unemployment insurance doesn't provide jobs, but its purpose is understood. A tax refund may not "stimulate" the economy, but it will help people cope.

Why can't economists ever look at the immediate concerns of people instead of worrying about the GDP?

[knzn]

Another thing one should take into account, both in evaluating the 2001 tax rebate and in judging the likely effectiveness of a rebate today, is that we are weighing the actual experience against an (implicitly unknown) counterfactual: "What would have happened without the tax rebate?" The observation that most people "saved the money from the tax rebate" doesn't really give us the answer. Without the tax rebate, people who were expecting a certain level of consumption might have found it necessary to reduce their expectations, in order to have a little bit left over for savings. With the windfall tax rebate, they had something to save and didn't need to reduce their consumption. Particularly today, with the aggregate personal savings rate at approximately zero, we can expect that people looking at their budgets are going to have sudden attacks of thrift. Give them a tax rebate, and it may delay the onset of these attacks until after the (potential) recession.

[anne]

Context is everything, and this is the Wall Street Journal editorial page and the argument is against a temporary tax cut since a permanent tax cut will supposedly be more effective. But, a permanent tax cut will further constrain government spending on needed domestic programs in future or force Concressional Democrats to risk more or a tax increase than may otherwise be necessary.

This is a trap for Democrats, and whether Bruce Bartlett means trap or no the Wall Street Journal surely means trap for Democrats. This is a political attack against the New Deal legacy, and is precisely what the compassionless conservative Wall Street Journal editorialists at least wish.

[save_the_rustbelt]

We need a total overhaul of both the personal and corporate income tax systems, but there are too many vested interests and too much political hot air to allow that to happen.

Many of us tend to focus on the tax rates, but without understanding the maze of exemptions, deductions, and credits the discussions of rates are rather phony.

I must say, the current system is very good for CPAs, so maybe I should just relax and take advantage of the dysfunction.

[Allan]

While I am not personally opposed to receiving money from Uncle Sam, the current state of the economy does not need a feel-good response. We have a housing-related problem, first and foremost, and the only rebate that will help in the short term is a quick fix for sub-prime mortgage holders. Forget that they may have been irresponsible, along with the lenders that sold them a bill of goods, and stop the bleeding immediately. That will slow down foreclosures and declining prices, which will positively impact all mortgage holders. We are in a unique situation and unless we address it directly, we will only be placing a band-aid on a gaping wound.

[howard]

although i generally agree with anne on most matters, i'm going to note here briefly that bruce bartlett is my idea of what conservatism in america should look like: honest and principled (and on the wrong side, but at least we can have a real debate with someone like bartlett, who is whom the times should have hired in lieu of kristol, but i digress).

as for the issue at hand, i favor the traditional keynesian stabilizers like revenue-sharing with the states and extended unemployment benefits. my attitude is that the heart of our problem is the recognition that we have much less capital that the glut-o-philes asured us, and that a contraction is therefore baked in and will last a while, so counter-cyclical stabilizers are more important than one-shot deals.

[hari]

I've a funny feeling Keynes would give a sh...if he's insulted or not by Uncle Sam.

What's in fact insulting is that some you can't seem to see beyond your noses! Why get into an ideological shril argument when Mark has outlined a stabalization policy framework and choices available...?

We know for a fact, here in EU, Uncle Sam is living off borrowed time ... either buckle up and make the right type of choice to get the sails up again...or the ship is likely to ground for a period of more than 18mths!

Neither GWB nor any other leader can solve the problems alone. It must be a consensus approach and intelligent to boot becuause there're a lot of weeds that need to be celaned and pruned for protection of your good life style.

[A student of economics]

If we want to make an apples to apples comparison of temporary vs. permanent tax cuts, they it seems we should look at cut with the same NPV.

That way, they have the same impact on the long term debt. A $500 temporary tax cut might have about the same NPV as say a $50 annual tax cut thats permanent. It's true that a higher percentage of the $50 permanent cut would be spent than the $500 temporary one, but that misses the point. It seems unlikely that the $450 of NPV that occur after the first year in the permanent tax cut would have the same stimulative effect as the additional $450 of the temporary tax cut. The key question is where should that extra $450 of cuts go to maximize the current impact, today, or in the future.

If, instead, you compare a $500 temporary tax cut to a cut of $500 per year in perpetuity, then the latter would have more stimulative effect mainly because its much, much bigger, not because its "permanent".

[jim]

Echo knzn. If my $1600 arrives before 4/15, I will almost certainly use it to fund my 2007 IRA. But if there weren't a rebate, I'd raid some other cash to fund my 2007 IRA anyway and restore it by reducing spending over the Spring and early Summer. If a survey were to ask me what I did with the rebate, I'd say I used it to fund my IRA and the economists using the survey would all conclude that the rebate had no stimulative effect in my case. But they would be wrong!

[Bruce Wilder]

This is conservatives seizing control of the political agenda to serve their own desire to continue the redistribution of income upward.

If people get these tax rebate checks and many use them to pay down debt, well, . . . good!

The pressing issue in this recession (and I don't imagine most post-WWII recessions have even had an "issue" other than some mistake by a Fed, which doesn't know that one should not invert the yield curve), the critical thing now is a major adjustment in the economy to increase saving, reduce imports, and increase exports.

It doesn't serve our national interests to follow Bartlett's version of Keynes, abstracting away from the choice of what to spend money on. It does matter. Long-term we have to start spending money, investing, in reducing oil consumption and carbon emissions.

U.S. households need to have a positive savings rate. If a check from Uncle Sam starts us down that road, good. But, let's get on with it.

And, let's do it with our eyes open.

This recession ought to be a wake-up call: the economic policy of the U.S. is broken. This is the hard landing from a pattern of behavior, which many said could not go on indefinitely. Well, it didn't, and now we have to shift gears.

And, in shifting gears, we are going to have to manage a reduction in American consumption. This is the issue, which is being buried by BB, in the post. Someone will have to bear that burden. Bush and his friends will try to find ways to cram it all down on the middle classes. But, they will hide that policy behind pleasing slogans and indirection.

Policy needs to address explicitly how the reduction in consumption spending will be handled, and how investment to reduce oil imports and carbon emissions, will be directed. Get it all into the open.

[anne]

The New York Times should have hired Bruce Bartlett, who has in the past written for them, on that I am completely agreed. Nonetheless, even when I might agree with Bartlett, I seldom find Wall Street Journal internal or external editorials tolerable. But, the Times missed hiring a fine editorialist for any of my disagreements.

says...

Allan:

"We have a housing-related problem, first and foremost, and the only rebate that will help in the short term is a quick fix for sub-prime mortgage holders."

Were I to have my way, which I will not, I would have Congress and the President work to convert significant numbers of high cost sub-prime mortgages to moderate cost long-term mortgages. I would expect a need for Congressional assistance since contract revision would be involved, if a serious push of lenders is to be made.

Beyond this, I would prefer direct government spending possibly beginning with federal-state revenue sharing to allow for work on green infrastructure programs. Then, I would choose a temporary tax rebate aimed at middle and lower income households.

[anne]

Sorry about my name being somehow left off the comment.

[calmo]

So many excellent comments, let me lift from howard:

although i generally agree with anne on most matters, i'm going to note here briefly that bruce bartlett [and this thread] is my idea of what conservatism in america [and serious noodling anywhere] should look like: honest and principled (and on the wrong challenging side, but at least we can have a real debate discussion with someone like bartlett, who is whom the times should have hired in lieu of kristol, but i digress [and who could resist a digression like this? not me ).

Great temptation to allow this marvelous freight train to continue unimpeded by my not-so-marvelous cheering.
Ok, the issue seems to have reduced itself to the wisdom of implementing a temporary tax rebate or a permanent tax cut. Do you suppose setting aside funds for specific projects/goals is just too demanding for this administration or izit just a foregone conclusion that this administration's capacity in developing policy starts and ends with 'tax cuts'?
$150B seems like a significant proposal, but let's remind ourselves of those pre-invasion estimates of the military adventure in Iraq.
After several rebates we might have wished for something more concrete, more specific, more intelligently responding to the financial morass.

[kthomas]

"After several rebates we might have wished for something more concrete, more specific, more intelligently responding to the financial morass."

calmo, you've a twisted sense of humor, but I could not agree more with you. Anything Bush touches turns to mud anyways.

[john c. halasz]

One thing that should not be done is attempt to prop up fictional housing values, which need to be brought back in line with with wages/incomes/rents, whether that occurs through asset deflation or general inflation. (I'm not sure how it would work, but Dean Baker's proposal that foreclosed mortgages have the option of being converted into market-rate rents looks like the right sort of idea). For the rest, yes, fiscal spending, starting with transfers to state governments and automatic stabilizers is much preferable to tax cuts, (which would have a poor multiplier due to poor targeting, debt overhang of households, and import leakage). And then, contrary to orthodoxy and reigning political ideology, we need to start working toward a (re)industrial(ization) policy, financing icreased public spending by raising taxes on the rich, which is the only way that I can see to address the wage stagnation which underlies so much of the problem. It's going to be a long, stagflationary recession, as far as I can tell. Allen Sloan says long and shallow, but I could see it deepening through international feedback loops, ( a sharp slow-down in Japan and EU, leading to slower in China and EM, etc.). And just wait til the bubble in foreign and especially EM equities pops, and our magically etherealized NIIP comes raining back down on us. Dark matter, indeed!

[anne]

There is a problem here that I have not understood for quite a while. Why has the continually increasing military budget not evidently spurred economic growth more? Why should we have slowed so significantly given $750 billion in military spending, not counting domestic security spending? We have after all lowered taxes several times during George Bush's Presidency, and though non-military spending has fallen as a portion of national income military spending has growth far faster and accounts for the deficit we have.

[john c. halasz]

Also, legislation needs to be passed subjecting mortgages to Ch. 13 bankruptcy cram-down.

[anne]

We have had then a massive increase in military spending since the initial budget of George Bush in 2002, along with a series of tax cuts and low long term interest rates, but recovery from the short and shallow recession of 2001 has been weaker than any I know of in 50 years. The recovery from 2001, has been accompanied by an increase in hourly and weekly wages of only about 1%.

[anne]

Also, why is there almost no discussion of what seems the most profound effect of the collapsing of what I prefer to call simply the high cost mortgage market? African American and Latino and, I am told, older homeowers are suffering much out of proportion from being sold excessively high cost mortgages.

African Americans were victimized by excessive mortgage costs for years, and beyond New York Times notice, there was no evident concern.

[Fred]

Well, I don't understand this. How did consumers run up these debts that they are going to pay off with the tax rebate? Obviously, saving was not a concern back when they were incurring the debts, so how can anyone be sure it will be a concern now? Certainly it is possible that there has been a sea change by households away from running up debt and towards repairing their balance sheets by drastically increasing savings. In which case the government must step in and play the role of the Great Debtor in order to allow the households to increase their position as the Great Creditors. The alternative is stagnation.

So if $1000 of tax rebates doesn't work, double or quadruple the amount. If the money leaks out due to a trade deficit, then impose an across the board tariff (legal under WTO rules provided it is truly across-the-board). This is better than trying to push down the exchange rate by driving interest rates back below inflation.

Negative real interest rates is a topic Keynes never addressed in depth, but it is clear from the past 20 years in Japan and the US that negative real interest rates primarily stimulate speculative asset bubbles rather than productive investment, and more speculation is NOT what we need right now.

[Michael Cain]

Making it easier for people to qualify for unemployment compensation, temporarily extending the time that benefits are paid...

TTBOMK, all 50 states now run "conforming" state plans, rather than allowing the feds to operate a plan for them. Certainly Congress can require states to allow easier qualification and pay benefits for a longer period of time in order to be "conforming" and most -- nay, all -- states will follow those changes because of the large federal tax increase that would hit their employers if the state failed to do so. I want to know if and how Congress will fund added expenses that occur in the long term.

Colorado is the situation I know best, and it's potentially nasty for the state. UI tax increases require a vote of the people, and have not been increased since 1992. The current tax rates and base are, statistically, unlikely to allow the state to ever accrue sufficient moneys in its UI trust fund to carry it through the UI demands of a severe recession. In such recessions, it is common for states to have a negative trust fund balance, and in such cases, the feds loan them money (at interest if the states fail to repay the loan within a short time) in order that benefits be paid. Many states issue bonds to repay the feds since they can often get a better interest rate in the market than the feds' rate.

Colorado's constitution does not allow borrowing across a fiscal year boundary or sale of multi-year bonds without a vote of the people. Such statewide votes can occur only at specific times that are not well-aligned with our fiscal year. If the state must pay expanded benefits in the early part of a recession, and the recession is an extended one, the state may find itself in the position of having to cut other programs in order to meet its UI obligations 18 months down the road. Colorado came very close to this after the last recession; only the very long boom period preceding it and the unexpected receipt of $125M in federal Reed Act funds kept it from happening.

If Congress requires Colorado to spend its UI trust fund now, will it cover cuts in other programs that result a year or two down the road?

[skeptonomist]

Mark says: "...others are trying to argue that the tax cuts must be permanent in order to be effective. But the effect of permanent tax cuts is not certain."

Let's look at some actual data from the real world. This graph

http://www.skeptometrics.org/Rct_Exp_GDP_bars.png

shows on-budget federal receipts and expenditures normalized by GDP, and also GDP growth averaged over presidential administrations (real, year-over-year, by quarter).

I think we know very well what the effects of permanant tax cuts are. The big tax cuts during the Reagan and Bush II administrations led to huge drops in revenue and massive deficits (since there were no cuts in expenditures). They did not lead to increased GDP growth. What Republicans called the "biggest tax increase in history" at the beginning of the Clinton administration was followed by vanishing deficits and GDP growth beating anything during Republican administrations since 1929.

Note also that growth was high, revenues were high and deficits were small from 1949 to 1969, when top-bracket income tax rates were usually above 90%.

Other factors played a role in the period since 1949 and it is not justified to say that Democratic presidents are always better for the economy than Republican ones, or that high taxes are necessarily good for the economy. But the data are absolutely not consistent with tax-slashers' arguments.

[STS]

Would Bruce Bartlett or any of the other assembled macro-economic worthies care to comment on the not-so-modest proposal from "Mad" Cramer: nationalize the monoline insurers, let Buffett (or other entrants) buy what bond insurance deals he can and put a specific payout bid on any insurance policies left in the "bag" (Cramer suggests 50 cents on the dollar).

Good idea? Bad idea? What else would you combine it with? (I would add a dose of regulation on mortgage origination, a path to stronger capitalization rules to and improved transparency rules on counter-party risk).

[lonesome moderate]

I don't see why there should be any tax cut at all, or any new spending programs. Since this recession is a creation of real estate/interest rate problems, I would think that the aim of government policy should be to give the Fed as much wiggle room as possible to cut rates without setting off an inflationary spiral. New rounds of either spending or tax cutting would create new demand for credit in the economy, which I would think would lead to either further inflation or either a rate increase, or a smaller cut than we could have had otherwise.

[anne]

Beyond the need to protect against the general debilitating effects of a recession that may easily be long and deep, there is need to rescue large numbers of people who were abused in being sold overly costly mortgages, many many many of these to Africans Americans who were qualified for lower cost mortgages they could have afforded.

That there is signal danger for wealth accumulation by African Americans simply does not seem to be noticed.

* James Cramer's idea would be politically unworkable, but resetting costs for fairness for those who hold high cost mortgage debt ought to be done when possible.

[donna]

The people struggling don't even pay taxes, or are those who have been laid off and might get what, one month's rent out of a rebate? This is all so ridiculous.

[Fred]

>Since this recession is a creation of real estate/interest rate problems, I would think that the aim of government policy should be to give the Fed as much wiggle room as possible to cut rates without setting off an inflationary spiral

This recession is the result of a speculative boom-bust cycle, which is the modern equivalent of the old investment driven business cycle. We do NOT want the Fed cutting interest rates because that just creates more speculation. Human psychology is such that we simply do not plan 100 years in advance, and yet that is what 1% real interest rates require us to do, if we are to make investments at 1% that we would not make at 3%. (These are real rates, ie inflation adjusted, as opposed to nominal rates.) 1% and lower real interest rates lead to speculation, not more investment.

Keynes talked of the euthanasia of the rentier and wondered why there was so little fixed capital to show for 5000 years of recorded history and hoped that government public works spending would eventually drive the return on capital to near zero, as capital became plentiful. He didn't think this through fully. What happens as the return on capital (the real interest rate) goes to zero is that any inflation-adjusted flow of income become infinitely valuable, since the reciprocal of zero is infinity. This is what we have been seeing in the US and Japan before. The result is a speculative boom, which either forces interest rates to stay low forever (thus leading to inflation) or else the boom collapses when interest rates are eventually raised.

As an aside, it is still possible to euthanize the rentier, but it should be done by income taxes rather than by driving real interest rates to zero. At a 33% tax rate and 3% inflation, 6% nominal interest equates to slightly less than 1% after-tax real interest, which effectively euthanizes the rentier.

The whole business of monetary policy is merely the result of evolution from the working of the Bank of England in the 19th century and was never something planned or carefully thought out. The Bank of England discovered, by trial and error, that manipulating interest rates seemed to smooth the business cycle, and then our own Fed just imitated them. But neither the Bank of England nor the Fed really knew what the hell they were doing, and neither did anyone else until Keynes. Keynes own theory makes it plain that fiscal policy is where the action is at and monetary policy is something of an afterthought. Had Keynes lived to see the asset bubbles of the last 20 years, he would no doubt have repudiated monetary policy for the most part. Just peg the real interest rate at 3% or so and let the Fed manipulate the tax rates every 6 weeks, the same as they currently manipulate interest rates. This tax-based fiscal policy would have been difficult in Keynes time, partly because they lacked computers then and partly because there simply weren't enough taxes to cut, but we no longer have that problem. In particular, rebates on the payroll tax, deposited directly to the worker's bank account, would be trivial to implement. As for the argument that the average worker, upon seeing his rebate "magically" increase from $77.11 one week to $113.59 the next week and then decrease to $88.44 the week after that, would somehow figure out what the average rebate is and save everything above this average as opposed to spending every penny like a drunken sailor--well, anyone who believes that is really detached from the average American.

says...

Bartlett says:

In short, there is virtually no empirical evidence that tax rebates are an effective response to economic slowdowns. ...

Which is contradicted by Laurence Seidman's article "Reviving Fiscal Policy" in the May-June 2001 issue of Challenge:

Recent Empirical Evidence on Fiscal Policy

. . . The empirical evidence implies that "temporary tax changes have large effects on the demand for goods and services” because an important share of the population are “spenders who live paycheck-to-paycheck."

. . . Matthew Shapiro and Joel Slemrod . . . provide evidence that even a very temporary tax change can significantly affect consumption. . . . a substantial fraction of consumers simply spend their current paychecks.

. . . Nicholas Souleles finds that there is significant evidence of high responsiveness of households’ consumption to their income tax refunds, implying "rather substantial macroeconomic effects of refunds, and more generally of fiscal policy."

And on the 1975 tax cut:

It is frequently asserted that “discretionary” fiscal policy—fiscal policy that requires Congress to enact a stimulus package—is impractical because it takes too long for Congress to act. However, discretionary fiscal policy responded promptly to the recession of 1975. From the time a consensus emerged that recession posed a greater threat than inflation (January 1975), it took just three months for Congress to enact a tax cut (end of March), and only another month for the increase in household disposable income to occur through the first tax-rebate checks from the Treasury (checks were sent out in April, May, and June).

A key element of the package was a one-time rebate of 1974 income tax: Each household received a check equal to 10 percent of its 1974 personal income tax up to a maximum of $200 per household. . . .

According to the DRI simulations, in the absence of the fiscal policy package, real GNP would have declined at a 6.2 percent annual rate in the second quarter of 1975 compared to small positive growth under actual policies. . . . The fiscal package was a decisive factor in reversing unemployment during 1975. . . . the fiscal package reduced the unemployment rate at the end of 1975 by a full percentage point.

[paine]

bw:
"U.S. households need to have a positive savings rate"

no
looked at in easy pieces
wage earner households
need a higher wage rate to off set
their sudden
lower borrowing rate

uncle needs to borrow for them
and keep their state and local gubs coookin along

as for the portfolio crowd
want em to invest more
give em a tax hike
thru dividend and gains rate increases
the wealth effect oughta out way the now effect
and increase their investment rate

nice scenario
upside down reagooonomics
the wealth effect

[James Killus]

The underlying theory for the rebate idea traces back to the British economist John Maynard Keynes. He believed that spending was the driving force in the economy. It didn't matter whether the spending was done by businesses on capital equipment, by governments on public works, or by consumers -- spending is spending in the Keynesian model, and all of it is stimulative. ...

Since Mr. Bartlett is apparently reading this set of comments, I'd like to see a citation for the above opinion, because it doesn't seem to be consistent with what I know of Keynesean theory. Did Keynes really say outright that digging holes and filling them up again was the economic equivalent of productive investment, or that blowing up another country's infrastructure is the same as building one's own? I find that most curious. Certainly it would be a major flaw in Keynesean economics if it were true.

In any case, the U.S. is currently running a massive deficit with huge trade imbalances. I suspect that Keynes would be capable of of modifying a theory that he devised to explain a severe deflation and shrinking international trade to account for changing circumstances. But I do like the implication that conservative economists believe that it doesn't matter whose pockets the money is stuffed into, and that Keynes is responsible for that belief. That explains rather a lot, really.

[yamada]

What will be the scale of the tax cut or the rebate, or injecting reserves to banks?
Is it enough to change the expectation of the people toward the economy in fact?
"Too little, too late" policy will work little on the economy as a result.
Or the tax cut or rebate must be permanently provided, as Mark seems affirmative.
Please remind, in the U.S. the real estate price has become about 300% from that of ten years before in average, and now is probably been adjusted only for 20 to 30% downwards.

[anne]

Bruse Bartlett:

"In short, there is virtually no empirical evidence that tax rebates are an effective response to economic slowdowns...."

http://mesharpe.metapress.com/app/home/contribution.asp?referrer=parent&backto=issue,3,9;journal,40,42;linkingpublicationresults,1:106043,1

May, 2001

Reviving Fiscal Policy
By Laurence Seidman

Thanks to ---- for saving me the bother of tracing what I now know for sure, for all the protesting nonsense, was a ridiculous compassionless conservative article. This is typical Wall Street Journal editorial page obfuscation, designed to cut taxes permanently for the sake of crippling domestic social programs and undermining the prospect of a continued Democratic Congress or Administration that may try to protect the health of, say, 3.8 million needy children possible let alone protect the health of far, far more.

Typical compassionless conservative pretense. Poor sweet misunderstood dear.

[anne]

The purpose of the Wall Street Journal, of Rupert Murdoch, is to make sure that given the insanely gobbling up of resources for needless military spending, which spending can never be enough to satisfy Murdoch, there must be permanent tax cuts making utterly impossible critical domestic social spending. Permanent tax cuts and the insanity of $750 billion in military spending, including the moral perniciousness of Iraq will an excuse to slash and bash Social Security and Medicare, let alone an excuse to turn from protecting the health of millions of needy children. So much for the New Deal legacy, this is definitive mean-spirited Ronald Reaganism.

[Cosi]

Bruce Bartlett,

Re: "I was not trying to make an argument for permanent tax cuts, I was only trying to argue against rebates."

Exactly what I thought, and tried to point out to Mark Thoma and others upthread http://economistsview.typepad.com/economistsview/2008/01/its-an-insult-t.html#c97750620

Don't let comments from knee-jerk hyper-partisans/ideologues like anne (and many others of both right and left) bother you. The sensible among us appreciate that you've been outspoken in challenging the orthodoxy -- the "known truths" -- of what was your "side", such as when you tried to get them to accept that the pervasive general statement that "tax cuts generate higher revenues" (and that the Bush tax cuts have done so) was baloney.

[Julio]

For states that have a sales tax, would a sales tax holiday (reimbursed by the feds) provide the kind of stimulus that's being proposed? It could be put in place extremely quickly, since all the administrative stuff is done already.

[anne]

http://www.nber.org/digest//apr05/w10784.html?tools=printit

April, 2005

How Households Responded to Tax Rebates of 2001

In March 2001, the U.S. economy entered a recession. In response, the Economic Growth and Tax Relief Reconciliation Act of 2001 included a large income tax rebate program intended to stimulate consumption demand and ameliorate the recession. The program sent tax rebates, typically $300 or $600 in value, to about two-thirds of U.S. households. Because there have been relatively few instances of such active, counter-cyclical fiscal policies in U.S. history, there was little evidence available on whether this rebate program would indeed help to end the recession. In other words, how much of their rebates would consumers spend?

Economic theory is generally pessimistic about the efficacy of such counter-cyclical tax policies. According to the rational-expectations Permanent-Income Hypothesis, households should decide on a level of consumption based on a long-term view of their resources. In this case, a single rebate would have little effect on spending. Further, the theory predicts that, in the absence of liquidity constraints, spending should increase as soon as consumers begin to expect some tax cut, and not increase only after they actually have received the rebate check.

Shortly after the passage of the 2001 Tax Act, David Johnson, Jonathan Parker, and Nicholas Souleles, working with the Bureau of Labor Statistics and other government agencies, added a special group of questions about the tax rebates to the Consumer Expenditure Survey, the most comprehensive ongoing measure of U.S. household expenditure. In Household Expenditure and the Income Tax Rebates of 2001, * they analyze the responses to these questions, and conclude that the rebates did increase consumer spending significantly, helping to end the recession of 2001.

Their analysis uses a unique feature of the rebate program. Because it was administratively difficult to print and mail the rebate checks all at once, they were mailed out over a over a ten-week period from late July to the end of September 2001. Most importantly, the particular week in which a check was mailed depended on the second-to-last digit of the taxpayer's Social Security number, a number that is effectively randomly assigned. This randomization allows the authors to identify the causal effect of the rebate by comparing the spending of households that received the rebate earlier to the spending of households that received it later. This also allows the rebates to be distinguished from other concurrent factors that affect consumption and might otherwise confound inference about the rebate (for example, concurrent changes in monetary policy, or the stock market, or the advent of zero-percent auto financing, and so on).

The authors find that "the average household spent 20-40 percent of its 2001 tax rebate on non-durable goods during the three-month period in which the rebate was received." Further, "[r]oughly two-thirds of the rebates were spent during the quarter of receipt and subsequent three-month period." In dollar terms, households increased their expenditures on food by $51 and their expenditures on non-durable goods by $179 on average in the quarter of receipt, which correspond to a 2.7 percent rise in expenditures on food and a 3.2 percent rise in expenditures on non-durable goods. These findings run counter to the Permanent-Income Hypothesis.

The authors also investigate whether some households were more likely to spend the rebate than others. They find that "[t]he expenditure responses are largest for households with relatively low liquid wealth and low income, which is consistent with liquidity constraints."

In all, the rebates totaled $38 billion, or about 7.5 percent of personal consumption expenditures on nondurable goods in the third quarter of 2001. The authors' estimates imply that the rebates increased aggregate consumption expenditures on nondurable goods by 2.9 percent and 2.0 percent in the third and fourth quarters of 2001. The timing and magnitude of this response is consistent with the rebate program playing a large role in counteracting the 2001 recession, which ended in the fourth quarter with strong growth in aggregate consumption.

* http://papers.nber.org/papers/w10784

[anne]

Thinking through the a suggested tax rebate, I find no reason to believe a significant portion will be spent fairly quickly, so acting as an important stimulus. That the rebate is temporary will be helpful subsequently, in avoiding a self-defeating political struggle over increasing taxes if necessary especially given the difficulty of cutting military spending.

The biggest problems with a rebate are that milliuons of low income persons will receive a payment, and direct infrastructure spending could well have a more meaningful economic and social effect.

[plschwartz]

excuse me, as a non-economist if I make some stupid comments.But much of what I read here does not relate to my understanding if the real world.
I grew up hearing stories of the CCC. So when I read of the idea of funding Public Works I first imagined a new CCC. But what American workers could go do manual labor today? Build roads fix bridges? First thats a long term fix. Second its highly mechanized and third highly unionized. Also will it lead to new construction machine orders. How much of this is US made. Are we just transferring this money to China.
Cash refund? Well maybe the idea is that money changes hands x number of times and everybody wins. I get $1000 and buy a new TV at Sam's Club. Their computer automatically sends a request to China. How much money gets passed around?
I see the careful attention is given to labor statistics. But with the great unknown of undocumented labor how meaningful are these statistics.

Perhaps we should put money into the service sector. What about food-stamp like vouchers which can be used in restaurants? A good meal always helps

[Cosi]

anne,

You are overlooking the degree of lag of the impact of infrastructure spending (and of course, timing is critical to the objective of immediate, timely stimulus). Check out CBO's analysis of fiscal stimulus
http://cboblog.cbo.gov/?p=56
and
http://www.cbo.gov//ftpdocs/88xx/doc8893/blog-econstimulustable.htm options

[anne]

Agreed; a tax rebate or Treasury payment is faster than I can imagine any federal-state infrastructure directed revenue sharing plan can be. Negotiating and beginning a federal infrastructure spending plan would be slow. A legislated plan directed to resetting subprime mortgage rates would be slow, if possible.

Darn; with Brad DeLong while I want the Federal Reserve to lower the Funds rate quickly and sharply I am less in favor of a short term fiscal stimulus which will have no significant effect on mortgage problems. Would there be time to work on broadly relieving excessive mortgage costs? Likely no.

I know, I know.

[philip]

What history of economics leads us to think that Keynes accurately predicted anything? He made a bunch of theories that neatly fit some input data, given his assumptions about cause and effect. Very-little-to-nothing of the unfolding events after his theories fits to his models unless you are very generous with interpretations and mitigating factors. And Anne, do you really believe that Reagan was mean-spirited? Believing he was wrong I can understand, but mean? I believe FDR was very well intentioned, while being a negative influence on U.S. economic and political development. And for the record I don't believe Reagan did well either, since he didn't cut spending to match his tax cuts.

[James Killus]

plschwartz, I can think of a thousand things that could be funded as physical or social infrastructure if there was a will to do them. There are millions of pages of past historical documents that have yet to be scanned or even catalogued. There are bridges to maintain and roads to upgrade, and huge environmental remediation projects such as removal of contaminants from groundwater. For that matter, there is an ongoing need for environmental data collection as baseline. There is also the matter of the slow squeezing of the poorer classes for educational funding. There was a time when a college education was not a 20 year lien.

And I do confess a nostalgia for the time when it was thought that perhaps science and engineering were good places for the "best and brightest" rather than the mergers and acquisitions department of an investment bank.

[Craig Nelson]

I'm with "A Student of Economics", a one-time $800 check must not be compared to a $800 annual raise.

Bartlett: "Thus Friedman predicted that the $100 to $200 checks disbursed by the Treasury Department in the spring of 1975 would have a minimal impact on spending, because they did not alter peoples' permanent income."

Response: Back of the envelope (and careless) calculations, say that if one values a one-time rebate as an earning stream and permanent tax reductions similarly, then a $100 one-time rebate is as valuable as a lifetime $8-10 annual tax reduction assuming 8-10% real ROI. Is Friedman being invoked to claim the signal on a permanent $8-10 yearly raise would be distinguishable from economic noise from the signal on a $100 rebate? Is Friedman being invoked to claim that spending 2/3 (66%)of a one-time rebate within 6 months (that pesky NBER report) will provide less stimulus than spending all (8-10%) of an equivalently costly tax rate reduction?

I think Bruce would be very unwise to keep disturbing Keynes and Friedman.

[Craig Nelson]

Anne asks: "There is a problem here that I have not understood for quite a while. Why has the continually increasing military budget not evidently spurred economic growth more?"

The answer that works for me is that the bombs and bullets produced don't enter the economy so there aren't goods for defense workers to spend their wages on. The defense budget primarily shows up as inflation.

[knzn]

I would say that the military budget has spurred economic growth, just not enough to make up for the trade deficit and the relative weakness of business investment during the current cycle. And I think the adverse psychological impact of the war has been partly responsible for the relative weakness of business investment.

[Craig Nelson]

I think "shows up primarily as inflation" was too bold, but with the defense budget being about 5% of GDP, it doesn't take a very steep aggregate demand curve to produce significant inflation. I don't know how steep that aggregate curve is, nor how much of the defense budget is channeled into accumulated wealth and retained earnings.

How does the diversion of 5% of the economy to defense affect the trade balance?

Is weak business investment due to anemic demand? Wages have stagnated and it took years for employment totals to recover from the 2001 recession so there has been little reason to increase capacity. Slow GDI growth drags down GDP growth.

[Craig Nelson]

knzn and anne,

More on military spending or as Chalmers Johnson calls it military Keynesianism and its effect on the economy and inflation.

From Johnson's article at Tomgram*:

"On May 1, 2007, the Center for Economic and Policy Research of Washington, D.C., released a study** prepared by the global forecasting company Global Insight on the long-term economic impact of increased military spending. Guided by economist Dean Baker, this research showed that, after an initial demand stimulus, by about the sixth year the effect of increased military spending turns negative. Needless to say, the U.S. economy has had to cope with growing defense spending for more than 60 years. He found that, after 10 years of higher defense spending, there would be 464,000 fewer jobs than in a baseline scenario that involved lower defense spending."

* http://tomdispatch.com/post/174884/chalmers_johnson_how_to_sink_america

** www.cepr.net/documents/publications/military_spending_2007_05.pdf

[knzn]

In the Global Insight model, the effect of military spending turns negative because of a crowding-out effect. I'm skeptical as to whether much crowding out has occurred in the current cycle. Certainly at the peak in 2006 there was crowding out, but for most of the cycle the economy has had slack resources, so there would have been room for more investment in spite of the resources devoted to the war. Possibly, without the war the recovery would have been weaker, and there would have been less investment, because of less anticipated demand by businesses. In that sense, it's possible that defense spending "crowded in" investment instead of crowding it out. (I should note, though, I'm using the phrase "crowding in" in a different sense than Ben Friedman used it when he (I think) coined it.)