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Same Old Arguments; Misunderstanding Economics as Full-Time Occupation

June 10, 2012

Here is an article that typifies the pseudo-intellectual debate about economics. You can see all the standard opening moves, thrusts, parrys and jabs in the comments. For the most part it breaks down exactly by party affiliation, yet again. One side says government should do more and the other side says that government should do less. Both sides think they have both moral and intellectual authority. So I want to take the three “myths” the author sets out to debunk and also a few points from the smarter opposing comments and line them up side by side, so to speak.

First the Myths:

  1. Firms are job creators.
  2. It’s the idea that governments should work by the same budgetary rules as families, typified by balanced budget requirements.
  3. Federal deficits are the scariest problem the economy faces.

On the surface of things, other than the condescending tone, there is nothing patently false in the author’s claims. Each of these three ideas are indeed myths, and pervasive ones at that. Now myth #1 & myth #3 I believe are more accurately seen as subterfuge and propaganda. In other words, people poll tested the term “job creators” and also found that debt and deficits provide enough of a scary cover story for doing what they wanted to do anyway – cut govt spending, cut taxes, deregulate. And quite possibly the misunderstanding of the difference between household budgets and government budgets is part of the confusion they are playing on. By going from something most everyone is familiar with and applying the metaphor incorrectly, you can forge a common sense misunderstanding in people’s heads that you can then exploit. All in all, these are not so much myths as they are lies. Deliberate lies, in my humble opinion.

But just because these are myths (lies) doesn’t mean that people are going to agree about the right and necessary steps going forward. Essentially, one side still says stimulus while the other side says cut spending, cut taxes, deregulate. I believe that there is a unifying understanding that both sides are glossing over or ignoring, but first let’s look at some arguments from the comments section:

1) The expectation effect. Keynsian stimulus, of the type advocated by this author, only works if people spend the money that is pumped into the economy. But people know that government debt must be paid off eventually, and that taxes in the future will be necessary to pay the debts accumulated today. Thus, they save more. Bye-bye stimulus effect.

2) Borrowing to take advantage of low interest rates is only sensible if you plan to pay the debt off when the debt matures. But nobody expects rates to stay this low, and nobody thinks that we will be paying down the national debt when today’s T-notes mature in 2, 3, 5, 7, or 10 years. So let’s say we borrow $1 trillion at a 0% interest rate with a 10 year term. In 10 years, unless we have budget surpluses, we will have to refinance that debt. Unless you have a plan to get to surpluses, or an expectation that rates will be very low in 10 years, borrowing the $1 trillion today is insanity.

3) The crowding out effect. Borrowing consists of selling treasury debt. We forget that there is a buyer on the other end of that transaction who is giving cash to the Feds. Well, once that has happened, that buyer’s cash is no longer available to invest in some other venture, or to spend either.

Sadly, argument #1 is an all-too-typical piece of economic nonsense (and they wonder why we resort to mocking economists sometimes). Yesterday I discussed an article where an economist was complaining that non-economists were finding fault with economics… only they didn’t understand the discipline well enough to be critical. The back and forth centered on the idea of “rational actors” and the critics said this is nonsense while the economist said, essentially, “we have behavioral economics, so ha! We know people aren’t simply rational actors, but ummm, we still have to model things that way.” This is the standard econ two step – first they make “simplifying assumptions” for the sake of the model, then they declare that the world works according to their embedded assumptions. It is a little bit more complicated than this, but the underlying assumptions in this first “rebuttal” comment come down to a couple of assumptions used in modeling: people act fully rationally about all things economic; people have perfect knowledge of economic affairs; this knowledge and rationality extends into the future, to infinity. It would be comical if it weren’t so sad.

Just to be fair, expectations can have an impact, certainly… There is an argument to be made (and some empirical data that is suggestive) that if you were to, say, give people a one-time stimulative boost they would treat it very differently than if they got an actual, long term wage increase. I mean, duh. People also spend more freely when they have confidence in their job security. The problem with putting money directly in people’s pockets right now (whether through temporary or permanent measures) is that people are up to their eyeballs in debt and will be paying that debt down instead of adding to demand with new spending. To believe that people do some kind of precise calculation on what the government spends and adjust their savings accordingly so they can pay it back in the future is, however, still absurd.

Argument #2 is far more interesting. Essentially the commenter is saying that cheap money isn’t cheap if we aren’t going to pay it off while it is still cheap. He has a point. To extend the bad metaphor of household to government finances, this is like an adjustable rate mortgage or an interest only loan with a balloon payment looming on the horizon. And on a broader note, I believe this is the thinking person’s argument against more stimulus… The fully justified belief that the government is not going to pay down the debt when times are better, as is the correct response if you buy into this Keynesian approach. This is not an insurmountable argument, but people are rightly skeptical – I share their skepticism, but on balance we have to do what we have to do… But I’ll get to that.

The third argument is relatively solid economics under normal conditions, but misunderstands the nature of our crisis. Here is a coherent explanation:

By itself an increase in the deficit, either in the form of an increase in government spending or a reduction in taxes, causes an increase in demand. But how this affects output, employment and growth depends on what happens to interest rates. When the economy is operating near capacity, government borrowing to finance an increase in the deficit causes interest rates to rise. Higher interest rates reduce or “crowd out” private investment, and this reduces growth…. When there is considerable excess capacity, an increase in government borrowing to finance an increase in the deficit does not lead to higher interest rates and does not crowd out private investment. Instead, the higher demand resulting from the increase in the deficit bolsters employment and output directly, and the resulting increase in income and economic activity in turn encourages or “crowds in” additional private spending. The crowding-in argument is the right one for current economic conditions….

So, essentially we have a crazy wrong argument about expectations, a valid point about the trend to continue piling up government debt (ie instead of paying it down on the “upside” of the cycle) and an argument that doesn’t actually work under these bizarro-land liquidity trap, balance sheet recession, debt deleveraging scenarios… And that is the intelligent response!

I do want to address the concern about debt, but from a different angle. It ties into the notion of jobs also. In simple terms, if we run trade deficits with the rest of the world – which we have been doing for a long time now, then we have to run up debt. It can be public, government debt or it can be private debt. There is no other way to make it work. So, ideally, we need to understand and counter-act the decimation of our industrial base and figure out how to get back to a trade surplus if we ever plan on repairing the economy. But that is a topic for another time.

I just want to note how tiresome these back and forth debates can be sometimes. I wish there were some new developments or some empirical finality to the hypotheses… If you really want to understand all of the standard moves, from openings to middle games to closings – Rook to Queens Bishop 6 – check out this wonderful piece by Mike Konczal. It is as if, having heard the arguments for the 1 millionth time, he set them all down and added some graphics so we could all agree to the shape of the debate instead of rehashing and mangling the same ideas over and over again. To dream, perchance to wake.

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