The Giant Chasm in Macroeconomics

Posted by: Michael Mandel on January 28

Faced with an economic crisis, politicians want to know: What would make things better? Or more precisely, they want to know if boosting spending and cutting taxes will help or hurt the private economy.

Unfortunately, there’s a giant dispute among macroeconomists about precisely this question. I wrote about it here:

You might think these simple questions would have clear answers. Remember, macroeconomists have been studying the U.S. economy for decades. After all this time, we should have some general agreement on the size of the “multiplier”—that is, whether an extra dollar of government spending leads to gross domestic product, or GDP, going up by more than one dollar, or less than one dollar. To put it another way, it’s essential to know whether the Obama economic package will stimulate the private sector or actually drain resources away from the rest of the economy.

An Intellectual War
In their analysis, the top Obama Administration economists, Christina Romer and Jared Bernstein, used a multiplier of roughly 1.6 for government purchases and about 1 for tax cuts. These figures suggest, for example, that a $100 billion increase in government purchases would lead to GDP going up by $160 billion. Out of that $160 billion, $100 billion would be the direct result of the original stimulus and $60 billion would be the increase in private-sector economic activity. A tax cut of $100 billion, by these numbers, would generate a $100 billion increase in GDP.

But among top economists, there is hardly consensus about the size of these multipliers, or even agreement about the right range. Instead, we are getting the equivalent of a full-scale intellectual war, with Nobel prize winners and leading economists actively attacking each other in public.

Take a look at the whole story.


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Reader Comments

CompEng

January 28, 2009 12:46 PM

It's not shocking that economists can't answer this question, because in order to answer it they would have to understand and talk about things they'd rather not admit.
The so-called "investor class" is the keystone of a capitalist economy in the sense that they "own" the economy, and fundamentally their spending is what drives the fluidity that makes the market go. But they have more money than they really have any interest in spending directly. The purpose of their money is to make money, so they don't have to. So instead of spending, they lend. This works for a while, but it's not really sustainable, because without the investor class actually spending, the debt comes due. This is actually the underlying nature of banking: money creation and debt creation are flip sides of the same coin, so to speak.

For this downturn to end, fortunes have to wiped out, debts have to be forgiven, and the trickle down economy restructured into something that serves a somewhat flatter consumer base. This is the nature of *every* capitalist "business cycle": a correction of unsustainable wealth and debt imbalances. This is a bigger correction than most because failsafes and globalization have allowed the imbalance to get a bit bigger.

Innovation, R&D, etc. don't change the nature of this. The tide lifts all boats to a degree, but the level of imbalance supported by a higher level of automation is actually higher. I think the higher the tech level a civilization has, the more straight capitalism will be insufficient.

I'd much rather we knew how to live, govern ourselves, and treat each other than try to throw technology at the problem. Of course, I'd rather have both. :)

Lord

January 28, 2009 04:38 PM

Stimulus has become an ideological and partisan focus rather than a scientific one. All stimulus is lumped together by those opposed to it, or stimulus is favored not by its stimulative properties but by which favors its agenda or constituents. Stimulus can be effective or not. The 2001 fiscal stimulus was so ineffective not even vigorous monetary stimulus could boost the economy until the 2003 fiscal stimulus was passed. Those opposed to stimulus wish to repeat those failures. The time has come to try it and see how effective it can be. No, it isn't expensive. Money can be printed and a little inflation now is just what is called for.

CompEng is right which is probably why this will prove to be a long term problem requiring a long term solution. This may just be the beginning.

Brandon W

January 28, 2009 07:35 PM

CompEng,
Interesting idea you propose, that " the higher the tech level a civilization has, the more straight capitalism will be insufficient." Just as previous economic systems were appropriate for their time in history, but would be catastrophically bad now, "capitalism" may be an idea whose time has expired. It may have been an economic system for another era. I'd love to see that honestly explored. We may be writhing and thrashing our way to a new system relevant to our time in history.

CompEng

January 29, 2009 11:12 AM

Brandon,
That may be so. Of course, I didn't invent the idea: it's another one with Marxist roots. That's why it's necessary to tread carefully: changing the nature of the social contract has broad-ranging effects. Some experiments like true Communism (as opposed to derivatives like Chinese communist-fascism) have really come to a bad end.
It's an interesting questions: how do you bust the big imbalances without creating entitlements and entitlement mentalities?

I generally favor capitalism with a few socialist adjustments: it's worked in the past in the US as long as we put sufficient backing into labor protections, progressive taxes, employment assistance, Unions, etc. Critics of unions say they didn't work, but just the fear that someone might consider unionization is really what has kept corporate pay scales "honest" in non-union industries.

If Union heads "got it" and realized that a certain amount of flexibility and planning for competitiveness ought to be part of the equation... and Unions more effectively went global, I think the downsides of globalization would be significantly less. But then the late seventies didn't have the same problems we have, and we still had the serious recession in 1981. It would be interesting to know more history on that score.

Mike Reardon

January 29, 2009 01:37 PM

About Mr. Mandel post, the hurdle to investing $100 billion of government stimulus and generating another $60 billion of growth comes from the private market banks not supporting investment. It is totally this lack of participation by the bank in lending into the markets that is the center of the problem. I don’t think private capital is going to support, fill in, or pick up any missing unfunded un insured segment of the economy.

On long term stimulus.. military spending that is a constant in the economy is holding up those stock values. Those stocks with military contracts are still doing well and supported, its only there public exposure that is draining on there values.

And think in terms of more stimulus supporting states budgets that are suffering continuing tax degeneration over that lost income and business activity. Find more money for local state banks.

and

Marxist or Republican, economies that become slaves to there most orthodox political ideologies are doomed to failure. Excesses that can not be regulated because they step onto toes of a political view continue onto the destruction of the whole system. Forget socialisms bends in this economy, it’s a capitalist economy that must gain effective regulation over financial sectors that were totally unregulated.

Joe Cushing

January 29, 2009 05:03 PM

I don't know what the multiplier is but burrowing money and spending it instead of letting capitalists spend it would have a negative impact on the economy. The multiplier has to be less than 1. It's a simple concept. If the government borrowed less money, the price of its bonds would go up creating a situation where there is a significantly negative or just very low return with great risk that the price will collapse when things turn around. This means people would be more shy about buying government securities. Where are they going to put there money? They would be forced to invest in the private sector. This would turn the economy around much faster than wasteful government spending.

In short, all this government spending is crouding out the much more effective private sector.

Maya Sole

January 30, 2009 10:40 PM

My Broker just advised me to sell all my stocks. I was always told to dollar cost average and buy low sell high. "This time its different" he said You're my best customer and would hate to see you get screwed.So I put it mostly in Bonds and some in my Vault just in case the Banks go Bad. Used to be we had a choice either Guns or Butter. Now we have nothing, Theres no money left in the system. It has virtually been evaporated by a huge sinkhole called the housing bubble and worsened by the consumer debt/credit Bubble.Now its taking everything with it, including the equity markets and commodities and millions of jobs.It had to happen.It was created to self destruct. Even Gold is having a hard time finding its way.I started to think about this economy spiraling out of control and remember when at the first sign of Blood, Bush came out and said our economy was very strong, It's resilient he said. Soon after the Panic set in. My Broker now advises to wait for the eventual collapse, when theres not an ounce of confidence in the markets.True Armageddon, Blood in the Streets. When all the jobs are gone and the US Currency is nearly worthless.Only then you may want to think about putting some money into hard assets only.Its gonna be a cold day in Hell when this bounces back.

Tim

January 31, 2009 12:11 PM

CompEng is right. When wealth is broadly distributed across the population, investors can increase their wealth by building products and services that cater to needs of that population. But, when the bulk of the nation's wealth becomes concentrated in the hands of a few, investors must increasingly focus on bilking each other. Hence the series of market bubbles we have seen.

There is a simple solution, and that is a highly progressive tax system that takes money out at the top and feeds it back in at the bottom. From the late 40's until the early 60's, the top income tax rate was over 90%. Kennedy lowered it to 70%, where it remained until Reagan. Of course, charitable donations were a popular means to avoid these taxes, and that accomplished the same end of putting money back in real circulation, while letting the wealthy choose their cause.

empedos

January 31, 2009 02:13 PM

CompEng has grasped the root cause of the current crisis, a cause no one dares to talk about.
"Investor class" and "flatter consumer base" are the issues we ought to be reading and talking about.
As long as policymakers do not recognize the imbalance that CompEng described, forget about any fast recovery.
My views on some technicalities of the proposed solution are somewhat different : instead of forgiving loans unconditionally, I favor the introduction of the condition "for those who have a potential to increase their private consumption".
From Greece (where the crisis is not yet apparent, thanks to all readers for their insightfull comments.

sam

February 1, 2009 03:03 PM

The basic problem is the belief that the government and the private sector exist on two different planets.

According to the old Reagan mythology, government takes our money and either burns it or blasts it to Alpha Centauri.

The truth is that government activity increases the supply of money by spending everything they take in.

All of the money comes back to the private sector as payments for goods and services.

We are in a situation where too much money has been put into the hands of right people who don't need to spend it.

If we raise their taxes the money will go to lower an middle class folks who will spend it instead of investing it in fraudulent instruments.

Frank Loweser

February 2, 2009 11:07 AM

I'm a Democrat, and voted for Obama. But even I can see that along with sensible spending on infrastructure including the grid, bridges, broadband, we need to throw money into refurbishing schools and providing extended safety nets. That's what the bill should do.
But we also need to cut corporate taxes in a way, written into the bill, that will reward companies for locating investments in the U.S. rather than abroad. I'm not for cutting corp. taxes if companies do not follow through with U.S. investments. But we must try it.

I also want people to stop saying that the bill gives tax credits to people who don't pay taxes. The bottom 40% in income pay payroll taxes and they are stuck with rising healthcare costs because of the failure of the Congress to pass universal healthcare. Thats a "tax" we don't talk about.

empedos

February 2, 2009 05:49 PM

A "highly progressive tax system" (Tim) that will reallocate wealth from the "investor class" (CompEng) which "doesn't need to spend it" (Sam) towards the "middle class" (Sam), will not work (there are more ways to elude high taxation than one may ever imagine).
We have to start from reengineering society first. As CompEng has put it "the higher the tech level a civilization has, the more straight capitalism will be insufficient". The US has almost reached such a technological maturity and the dilemma now is : decline or a new social deal suitable for technological pioneering?
President Obama has a unique opportunity provided he sees clearly what has to be done. Unfortunately, he has chosen to be surrounded by an army of financial advisors mostly. Decline is my bet and it will be painful for the entire world.

Joe Cushing

February 3, 2009 12:06 AM

Oh Frank where do I begin?

My Broadband comes from AT&T. Why does the government need to spend my money on it? I pay for it with my monthly fee and get great service. If I didn't get great service--I have 2 other land line providers and 2 wireless providers I could choose. I don't need government money waisted on something I already pay for myself. How would the government know how to provide me with the service I want?

What does the the federal government have to do with schools? Why do we even have a department of education? Just stop it already. Schools are a state function. Besides, schools get plenty of money. They have great buildings already. Money is not the problem with education--it that there is too much government control. We need more private schools.

Stop trying to manipulate people with the tax code. If you want people to locate business here, cut the corporate tax code across the board. We are in a close second place for the 1st worlds highest corporate tax rate. One reason to move jobs overseas is to avoid paying 35% of every dollar earned to the government.

The reason we have rising health care costs is because government is already too involved with health care. Making universal healthcare will make things worse, not better. Lets get the government out of the health care business and things will improve.

Mike Reardon

February 3, 2009 03:46 PM

In a AP story in Business Week, JPMorgan's CEO Jamie Dimon refutes my post above centering on bank lending. OK. But he does point to the bigger hole in lending from money market funds and hedge funds that support financial paper. And I say they are not stepping up to support infrastructure investment.

http://www.businessweek.com/ap/financialnews/D9647R0G1.htm

Any growth that the economy sees may need to be made of pure pork infrastructure pushed into the states and paid for by the Administration. And the secondary effects that this spending has in the local retail markets.

Remember houses selling at new deflated prices directly impact forward revenue the states will gain in property tax. It still holds I don’t think private capital is going to support any unfunded uninsured segment of the economy.

CompEng

February 4, 2009 08:52 PM

I think Empedos is right that progressive taxes are far less effective at redistributing wealth than you would expect. The market absorbs tax costs into its labor cost equations fast enough that it probably doesn't make that much different.

Thank you for your interest. This blog is no longer active.

 

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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