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Sunday, October 20, 2013

Ideology and Macroeconomics

Arnold Kling:

Ideology and Macroeconomics, by Arnold Kling: Scott Sumner writes,

I am amazed by how many proponents of fiscal policy don’t understand that it’s symmetrical. Fiscal policy doesn’t mean more government; it means more government during recessions and less government during booms, with no overall change in the average level of government. Anyone who doesn’t even get to that level of understanding, who doesn’t think in terms of policy regimes, is simply not part of the serious conversation.

I agree with the first two sentences, but not with the last.

Yes, in theory, there should be economists who, as they argued for more stimulus in 2009, should at the same time have been arguing for entitlement reform or other reductions in future spending. Other things equal, the bigger debt that we have accumulated over the past five years would make a non-ideological macroeconomist want to propose tighter fiscal policy somewhere down the road.

But “nonideological” and macroeconomics are nearly oxymorons. ...

Huh? See here (from 2005, before the recession had even started):

... To use fiscal policy to stabilize the economy however, you have to spend more or tax less in the bad times (increase the deficit) and then do the hard thing which is to raise taxes or cut spending in the good times (decrease the deficit).  To keep the budget in balance the good has to be matched somewhere by the bad.  If you cut taxes for this disaster, or this recession, or this war, and don’t raise them later, what do you do next time?  Cut again?  Okay, what about the time after that?  It won’t work forever.  The priming of the economy during the bad times must be matched by a slowdown during the good.  Borrow when income is low, pay it back when income is high. 

Furthermore, in stabilization policy, it’s also not possible in the long-run to use both government spending and taxation at opposite points in the business cycle.  That is, suppose you cut taxes during the bad times, then cut spending during the good times to pay it back.  That will work for a recession or two, a hurricane or two, but it won’t work forever because eventually there will be nothing left to cut out of government.  The opposite will not work forever either.  If you increase spending during the bad times then increase taxes during the good, the size of government will grow indefinitely over the long-run.  In more graphic form:

G↑ (rec) → T↑ (boom) →  G↑ (rec)→  T↑ (boom)  → G↑  (rec) → T↑ (boom)  →  bloated government

T↓ (rec) → G↓ (boom) →  T↓ (rec)→  G↓ (boom)  → T↓ (rec) → G↓ (boom)  →  no government

These two policies, or some combination of them (increase G and cut T in recessions, do the opposite in booms) are sustainable:

G↑ (rec) → G↓ (boom) →  G↑ (rec) →  G↓ (boom)  → G↑ (rec) → G↓ (boom)  →  sustainable size of government

T↓ (rec) → T↑ (boom) →  T↓ (rec) →  T↑ (boom)  → T↓ (rec) → T↑ (boom)  →  sustainable size of government

The Democrats are accused of adopting the first strategy and bloating the government.  The Republicans claim to adopt the second strategy to shrink government, but they’ve bloated government themselves (take the second line and change it to T↓ (rec) → G↑ (boom) → etc., a clearly unsustainable path).  Neither party seems willing or able to use either the third and/or the fourth lines as a means of stabilizing the economy.  We are seeing that now, and maybe even less stable budgetary variations.  The WSJ and other members of the GOP seems to advocate T↓ (rec)→ T↓ (boom) → etc. which, without cuts in G, cause deficits rise no matter how much they claim otherwise. 

There are, of course, lots and lots of variations on these basic chains of events, e.g. to adjust the size of government the first or second strategies can be adopted temporarily, and you hope lawmakers would put all their cards on the table as they do so whichever direction government size is to be adjusted.  But fiscal policy that is sustainable in the long-run, through recession after recession, natural disaster after natural disaster, war after war, has to adopt some combination of the third and fourth lines.  ...

Or here (from 2008, a bit afer the recession started):

Short-run stabilization policy for the economy during a downturn involves either cutting taxes to stimulate consumption and investment (and sometimes net exports), or increasing government spending. Which of these is used and the specific policy adopted has important implications for the effectiveness of policy, but no matter how it is done it will raise the deficit, and the increase in the deficit is often used to oppose the policy.
Theoretically, however, there is no reason at all why short-run stabilization policy ought to impact the long-run budget picture. Ideally, the deficits that accumulate during bad times are paid for by raising taxes or cutting spending during the good times so that there is no net change in the budget in the long-run.
Historically, we have been pretty good at spending money in bad times, but not so good at paying for the spending when times are better. But if we are serious about stabilization, that's what we need to do. When output is below the long-run sustainable rate we increase economic activity by deficit spending, and when output exceeds the long-run sustainable rate, we decrease activity by running a surplus. Doing this fills the troughs with the shaved peaks from the booms and keeps the economy closer to the long-run trend value.
I've been wondering if the current crisis will change our attitude about paying for stabilization policy, i.e. if it will make us more willing to raise taxes and cut spending when times are good. One of the problems with the last two boom-bust cycles was unchecked exuberance. Any calls to raise taxes or interest rates were met with howls about how it would cut off the boom, and who would want to do that? But tempering the boom might have helped to reduce the size of the meltdown we are experiencing now and left us much better off.
When the next boom develops, will we be more willing to raise taxes, cut spending, and tighten Fed policy? Will we remember what happened when the previous two booms ended and be more willing to step in and slow down the booming economy, will we be less susceptible to the argument that doing so will eliminate creative and productive innovation (as opposed to misdirecting resources during the mania phase)? This doesn't mean creating a recession or slamming on the brakes so hard we hit our heads, it doesn't mean ending innovative activity, it simply means what it says, bringing the growth rate down to its sustainable rate, and attenuating the exuberance that leads to housing and dot.com bubbles. Will we be more willing to take the necessary steps the next time the economy begins to boom?
I doubt it.
And the problem is that if we aren't willing to pay our bills during the good times, then it will be much harder to spend the money we need to spend when times are bad -- our hands will be tied when it comes to stabilization policy. ...

I could go on, but I'll just simply note that Krugman has been arguing (more than once) that there is little evidence that expansionary fiscal policy in recessions is permanent.

Oh, and since we are talking about unwillingness to reverse policy for ideological reasons, are conservatives arguing that the tax cuts they call for in recessions ought to be reversed when the economy improves? Why aren't those who are so worried about reversing policy in good times only talking about the spending side of the equation? Could it be -- gasp -- that their ideology, there belief that government is too big, is the reason?

    Posted by on Sunday, October 20, 2013 at 08:57 AM in Economics, Fiscal Policy, Politics | Permalink  Comments (44)

          


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