Tuesday, February 10, 2009

Just What the Hell Do the Economists Think?

GMU Economics Professor Jim Boudreaux:

“Conventional wisdom in Washington is that we must do something regardless of how wise or prudent it is,” said Boudreaux, the keynote speaker at an economic recovery event cosponsored by Heritage and the Club for Growth. “It’s taken as a matter of course that we must spend wildly.”

Instead, Boudreaux said, history offers a lesson that shows massive spending programs, such as those advocated by President Franklin Delano Roosevelt as part of the New Deal, do not work. “FDR’s policies put the ‘great’ in Great Depression,” Boudreaux said. He cited unemployment, which never dipped below 14%, and comments made by FDR’s own treasury secretary, Henry Morgenthau, who lamented that spending didn’t work. Should the United States fall into a deeper recession or depression, Boudreaux said, it would be the result of economic policies like those Obama is pursuing as part of his stimulus proposal.

New York University Assistant Economics Professor Mario Rizzo:

New York University assistant economics professor Mario Rizzo kicks off the second morning panel “Market-Based Solution.” He begins by taking fire at the macroeconomists who are claiming they know exactly how many jobs each version of Obama’s Trillion Dollar Debt Plan will create.

Rizzo says:Unfortunately, much of the policy advice offered recently by commentators, including many economists, is shockingly superficial. It is reminiscent of the simple prime-the-pump ideas of the early Keynes and does not acknowledge Keynes’s own cautions and qualifications after the General Theory was published.” Rizzo then went onto stress that the microeconomic realities were the key to real economic recovery: “I wish to emphasize the resource allocation issues that characterize both the current situation and its underlying causes. The macroeconomic way of thinking ignores the complexity of our system and generates
policies that will not bring lasting recovery.”

Turning to solutions, Rizzo recommends: First, allow the market adjustments to take place. When economic agents are confident that prices will be allowed to equilibrate, they will begin to take action in both financial and economic areas. Second, the current atmosphere of uncertainty has created an increase in a reluctance to lend, borrow, invest, and consume. Neutral stimulation can do some good. The only way stimulation can be neutral is through tax cuts, because only they encourage economic activity in accordance with voluntary decisions of economic agents.

Temporary cuts like the one in Obama’s plan will not work just like the rebates in Bush’s 2001 tax cuts do not work. Permanent and across the board cuts are needed and a cut in the corporate tax rate would be the most helpful. But these tax cuts must come with credible commitments to cut back on future government spending or they stimulative effects will be canceled by expectations of future interest rates.

Economist Arnold Kling:

Kling begins somberly: “I think about the stimulus as an economist but I feel it as a father. Barack Obama is destroying my daughters’ future. It is like sitting there watching my house ransacked by a gang of thugs. That’s how I feel, now back to how I think.”

Kling says this is a big bill, but not a big stimulus. There is nothing timely, targeted, or temporary about it. It is a simple transfer of money from one set of people to favored interest groups of the Democratic Party.

If economists had designed a plan, instead of Democratic politicians, it would look a lot like Greg Mankiw’s plan which calls for an immediate and permanent reduction in the payroll tax, financed by a gradual, permanent, and substantial increase in the gasoline tax.

Kling stressed that profits are the key to economic recovery. Profits and losses are signals in a market economy. Huge losses in the financial sector signal that that sector needs to shrink. Instead Obama is talking about buying and insuring toxic assets. They think they can force the financial sector to lend. But if businesses are not profitable then it makes no sense to lend. Cuts in payroll tax would make businesses more profitable.

Heritage Institute Senior Fellow JD Foster:

JD also predicted that President Obama’s Trillion Dollar Debt Plan will only deepen the recession. The CBO has already said so, noting that “in the long run it will lower aggregate output (GDP) by 0.1 percent to 0.3 percent.” Foster believes it will actually be worse. He explains that the unprecedented levels of debt required to fund Obama’s spending binge will drive up interest rates across the board. It well send our debt to GDP ratio soaring by 25%-30%. This will in turn drive up interest rates by a full percentage point by 2010. This debt will be a millstone around our economic necks for years to come.

Finally, responding to a question from the audience, Foster said that it was insane that anyone could think an economy could recover while staring down the barrel of a 12-gauge tax hike … like the ones scheduled for 2010. Not to mention the ones needed to pay for all of Obama’s reckless borrowing.

Gary Becker (1992 Nobel economics laureate) and Kevin Murphy (University of Chitown Economics professor):

In a full-employment situation, increased government spending would largely replace private spending, so the net stimulus to GDP would likely be quite small. In the present environment, however, with growing unemployment of both labor and capital, the net stimulus would be larger since the additional government spending would put some unemployed resources to work.


[O]ur conclusion is that the net stimulus to short-term GDP will not be zero, and will be positive, but the stimulus is likely to be modest in magnitude. Some economists have assumed that every $1 billion spent by the government through the stimulus package would raise short-term GDP by $1.5 billion. Or, in economics jargon, that the multiplier is 1.5. That seems too optimistic given the nature of the spending programs being proposed. We believe a multiplier well below one seems much more likely.


The evidence of past expansions of government programs is [that] [o]nce created they tend to survive and grow over time, even when the increases initially were said to be temporary. The underlying reason for this is that interest groups develop around new and expanded programs, and they lobby to keep and expand those programs.

This implies that the spending programs in the stimulus package will continue to some extent after the economy has returned to full employment. The multiplier at that time will surely be much closer to zero. Looking several years ahead, then, the average stimulus from the expansion in government spending will be smaller, perhaps much smaller, than the short-term stimulus.


Whatever the merits of other government spending, the spending in this package is likely to have less value. A very large amount of money will be spent quickly over a two-year period: $500 billion amounts to about one-quarter of the total federal government annual spending of $2 trillion. It is extremely difficult for any group, private as well as public, to spend such a large sum wisely in a short period of time.

In addition, although politics play an important part in determining all government spending, political considerations are especially important in a spending package adopted quickly while the economy is reeling, and just after a popular president took office. Many Democrats saw the stimulus bill as a golden opportunity to enact spending items they've long desired. For this reason, various components of the package are unlikely to pass any reasonably stringent cost-benefit test.


The increased federal debt caused by this stimulus package has to be paid for eventually by higher taxes on households and businesses. Higher income and business taxes generally discourage effort and investments, and result in a larger social burden than the actual level of the tax revenue needed to finance the greater debt. The burden from higher taxes down the road has to be deducted both from any short-term stimulus provided by the spending program, and from its long-run effects on the economy.