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Thursday, February 17, 2011

Chris Matthews' Improper Use of Stimulants

Recently Chris Matthews on his show HARDBALL continued to argue that direct payments were a far more effective stimulus than tax cuts for our economy.  He said, 
It seems to be that all those who studied economics in school understood what stimulus is. When the government spends money, people are getting their paycheck, they go to the corner store, they spend the money, they got to the corner store, the woman there, she spends the money. The money gets multiplied, and gets the money moving. And especially among poor people who live right up to the edge, in fact, beyond the edge in terms of economics. It’s vastly stimulative.
Rich people on the other hand, when they get a tax break, put it away. They don’t need the money a lot of cases. They put it -- they sock it away in whatever accounts they’ve got. They might try to find something to invest in, but it’s not going to stimulate the economy right away.
As I explained in my blog post Surreal is this Blindman’s Budget, this is historically untrue based on the results of previous spending increases.  The stimulus act of 2009 has been widely panned as ineffective.  This followed a previous attempt by President Bush to stimulate the economy by sending direct payments to taxpayers in 2008.  These futile efforts should have ended the hope for a miracle from Keynesian spending.  Despite the Reagan model, for Obama and other liberals the fallacy continues to be the truth.

The primary argument for spending increases flows from John Maynard Keynes’ The General Theory.  In it, he maintains that during a downturn, the economy needs a jump start; a sort of defibrillator to get the blood moving again.  As the economy falters, demand weakens as people are more circumspect in their spending as their earnings decrease.  As this demand weakens, businesses begin to reign in supply slowing production which further depresses demand.  Keynes General Theory purports that once this cycle has begun, only large scale Government spending can reverse this cycle and jumpstart the economy.

Aside from the empirical evidence, there are strong arguments opposed to such spending.  First, it must be noted that Keynes work developed during the Great Depression.  Unemployment insurance, Food Stamps, Earned Income Credits, Child Tax Credits, Temporary Assistance, Medicaid, Medicare, Social Security are all commonplace features in our current economic model which were not in place at that time – at least not in their current form.  Our economic infrastructure has automatic government spending increases built into it.  When jobs are lost whether temporary or permanent, a combination of savings, assistance and unemployment insurance replace much of the lost wages temporarily.  Just like an IV, these entitlements work to maintain a minimum level of demand while giving time for the economy to recover.  Any additional monies given by the government will not increase aggregate spending but simply rearrange the allocation of funds to maintain current demand.  An extra $500 will not cause the unemployed to take a vacation.  It will usually allow him or her to delay a withdrawal from savings or to pay off high interest debt.

For those of us whose debt is too high or savings too low, this is the best resting place for any additional check we receive.  This is the second reason why direct payments are inefficient means of fighting a recession.  I explained a few days ago that my family needs to purchase a new oven.  It’s a need, so we will buy a stove one way or another.  If the government sent me $500 tomorrow, it wouldn’t change my decision to buy a stove.  At most, it would simply change my method of paying for it.  Instead of using savings or credit, the new money would simply take its place.  No additional money would be spent.  It would be much like the Cash for Clunkers which simply moved the timing of new car purchases, but did little to increase them.  Following the 2008 one-time payments under Bush, Cogan and Taylor found, “More than $1 trillion in federal-deficit spending did little or nothing to help the economy. Why? Because it was used to pay down debts and reduce borrowing.”   People on the edge simply can’t afford to splurge when savings are low and debt is high, nor should the government be encouraging it.

Our national economy can be thought of as an organism.  It is self-regulating.  It has defensive mechanisms to protect itself.  If imports increase, the value of the dollar decreases which makes our exports more attractive.  As we all learned in Econ 101, the laws of supply and demand ensure that the invisible hand of the marketplace regulates it.  Light regulation should exist to prevent the unscrupulous from profiting illegally.  Occasionally the balance is offset by various factors - some seen, some unseen that will bring economic growth into reverse.  Often this is simply a course correction, much like a driver overcompensating as he steers out of a curve.  The worst economic disasters have been made worse by government intervention, though.  Just as having the backseat passenger grab the wheel as the driver tries to correct his path, government intervention is often inexact, unneeded and sure to include unintended consequences.  As Harvard University Professor of Economics, Greg Mankiw, in his 2003 remarks made while Chairmen of the Council of Economic Advisors under President Bush said, “The U.S. economy is remarkably flexible and resilient. Had we done nothing, the economy would eventually have recovered from the recession.”  

Attempting to handpick and target where to intervene is a fool’s game.  The government is simply not knowledgeable and nimble enough to effectively intervene in the marketplace.  The most effective move that government can make is simply to ease any restrictions on productivity.  Like we might treat a patient going into shock, we need to loosen anything that may be restricting the flow of money.  Those restrictions are taxes and regulations.  Jumpstart the heart and it can pump all it wants, but if the flow is restricted, the patient is still in trouble.

In our current economic troubles, easing some regulatory burden may have went a long way to preventing much of the disaster that took place in the banking system.  The Mark-to-Market accounting rule forces banks to value their holdings at what is the current fair market value.  It was eliminated by FDR in 1938 and reinstituted in 2007 following the Enron scandal.  As the housing market bubble began to burst, the value of certain mortgage funds began to devalue.  The banks, by this regulation were forced to immediately lower the value of their holdings.  This disrupted the appearance of solvency as the banks were forced to count these holdings as a loss even though they hadn’t been sold.  This began a cycle that eventually ended with the failure of banks.  The Fed stepped in and had to raise the FDIC backing to halt a run on consumer banks.  At the time that this took place, much of the devalued mortgages were still being paid on time and in no danger of default.  Ending MTM, temporarily lifting it or implementing a new rule to allow for a rolling average to be used may have saved the day.  But the government failed to act at the time.

Instead we had TARP interfering in the banking system and the stimulus package attempting to resuscitate the economy.  Shovel ready works projects, supplemental aid to states and targeted green projects will have cost us anywhere from $800 B to over a trillion dollars by the time the stimulus runs its course.  But what will we have to show for it?  According to the empirical and historical evidence - not much.

The key to government spending (investment) is the multiplier (return).  President Obama wants us to consider government spending as investing.  Okay fine, but when I invest my money, I want to know what sort of return I can expect to receive.  Let’s see just what type of return we can expect to receive on Obama’s investments.  As I’m sure you are aware, past results are not a guarantee of future returns.  But that doesn’t mean we should go into this blindly.

For each dollar that is put into the economy from spending or tax cuts, how much does the GDP increase – that is the multiplier.  Professor Mankiw assembles some terrific findings on his blog.  In studying increased spending since WWII, several researchers have placed the multiplier from government spending in a range from 1 to 1.4.  A multiplier of 1 would mean is that if you spend a dollar you get a dollar.  What this research shows is that there is either no multiplier or at most a very small one for increased spending.  On the other hand, Christina Romer and David Romer have concluded that the multiplier from tax cuts is 3.  In other words, a dollar of tax cuts will result in an increase of $3 in the GDP.  Tax cuts are 2-3 times as effective as spending.  According to the Keynsian models, it should be the opposite.  But as Mankiw explains,

How can these empirical results be reconciled? One hypothesis is that that compared with spending increases, tax cuts produce a bigger boost in investment demand. This might work through changing relative prices in a direction favorable to capital investment--a mechanism absent in the textbook Keynesian model.

Suppose, for example, that tax cuts are not lump-sum but instead take the form of cuts in payroll taxes (as suggested by Bils and Klenow). This tax cut would reduce the cost of labor and, if labor and capital are complements, increase the demand for capital goods. Thus, the tax cut stimulates demand not only by increasing disposable income and consumption spending (the textbook Keynesian channel) but also by incentivizing more investment spending. A similar result might obtain if the tax cut included, say, an investment tax credit.

As empirical research continues to show, the Keynes model fails to predict reality - taxes move the multiplier and not spending.  Mountford and Uhlig in their research stated,

As with Blanchard and Perotti (2002) we found that investment falls in response to both tax increases and government spending increases and that the multipliers associated with a change in taxes to be much higher than those associated with changes in spending.
Even Keynes himself, several years after The General Theory was published wrote,

Organized public works, at home and abroad, may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organisation (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.” -- Keynes, Collected Works, vol. XXVII, p.122
To put it bluntly Chris, you're wrong.  I will abstain from the foolish name calling that you like to indulge in.  I won’t assume you’re uneducated.  I’m sure you were taught Keynes over Milton Friedman in school.  But perhaps it wouldn’t be too much for you to occasionally pick up a newspaper or a magazine, maybe check out the internet to see what's happening in the real world.  I know you are busy doing a news show every night, but maybe you should know what you are talking about before you go and call anyone stupid, dumb and uneducated just because they know more than you.  After all, I’d hate for anyone to call you a bubble-head.

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