Archive for March, 2011

Eldridge Economics Part 2 — The Stimulus and the CBO

Thursday, March 3rd, 2011

Today let’s discuss the stimulus package, and the predictions made by the CBO. And in particular, how supporters of the stimulus bill continue to cite the CBO for writing that the legislation created millions of jobs. This will all tie into Eldridge Economics. Eventually.

First let’s go back to the beginning. In late 2008 during the election, the economy was stumbling. We were headed into a recession. Politicians from the left and the right agreed that something needed to be done. The President developed his economic stimulus plan. It was originally estimated that the bill would cost $787 billion. Two of the President’s key economic advisers, Christina Romer and Jared Bernstein, famously predicted that the stimulus bill would keep the unemployment rate below 8%. There were critics of the bill.

Paul KrugmanHardcore Keynesians: There were those on the far left, including the New York Time’s chief economist and columnist Paul Krugman, who advocated for a $2 trillion stimulus package. Remember, according to Keynesian Economics, the more money the government spends, the more the GDP will grow, and the more jobs are created.

Free Market Economists: There was a group on the right, like some of  the economists at the Wall Street Journal and Investor’s Business Daily, who warned that the stimulus package would hurt the economy and make things worse. That we would be better off doing nothing than passing the President’s bill. Critics also explained that the bill was more about big government spending than economic stimulus. Here’s one example from the WSJ.

The CBO: And then there was the CBO somewhat in the middle. Using their Keynesian model, they predicted that the stimulus bill would indeed create millions of jobs. But they ALSO warned that by the end of 2011, there would be little NET job growth. In other words, we were going to spend nearly $1 trillion to end up at the same place a year and a half later.

President Obama said that the stimulus was the right bill at the right time. It was necessary, and must be passed immediately. Congress obliged and passed the bill.

So what happened? Things got worse. Unemployment escalated towards 10%, and has continued to hover around 9.5% for months.

The President and the White House did what all politicians do. They engaged in revisionist history. They had to admit they were wrong to prove that they were right. How were they wrong? Because the economy was worse than they thought. How were they right? Because their stimulus plan created millions of jobs and kept us from a depression.

How can they do this with a straight face? Because Keynesian Economics says that government spending creates jobs. And to admit that it did not would be to admit the Keynesian Economics is wrong.

But the CBO Says That It Created Millions of Jobs!
Defenders of the White House continue to quote the CBO who wrote as late as this last November that the stimulus bill “Increased the number of full-time-equivalent jobs by 2.0 million to 5.2 million compared with what would have occurred otherwise.” The quote is from this CBO report.

The problem with citing the CBO? They don’t research and attempt to determine whether or not the bill actually created these jobs. So how did they come to their conclusion? Because they continue to plug the numbers into the same Keynesian formula. The CBO uses multipliers to predict how government spending increases GDP. They have different multipliers for different ways the money is spent. Brian Riedl from The Heritage Foundation (a rightwing organization) has explained this in detail. Here’s a link to one of his articles.

With the CBO’s most recent report they adjusted their predicted cost for the bill to be $814 billion. They plug the government’s expenditures into their model. And they predict the growth in GDP, and predict how many jobs are created FROM the growth in GDP.

So in other words, the stimulus bill lives in a vacuum. If the model predicts that the bill will create two million jobs, and the economy loses four million jobs, then their conclusion is that without the bill the economy would have lost six million jobs. Or if the economy creates five million jobs, their conclusion is that the economy would have only created three million jobs without the stimulus bill. So no matter what happens in real life, they continue to predict that the stimulus bill creates jobs.

If you read the entire report, they explain their methodolgy: “The Congressional Budget Office (CBO) based its estimates of the economic effects of the American Recovery and Reinvestment Act of 2009 (ARRA) on information from various sources: macroeconometric forecasting models, general-equilibrium models, and direct extrapolations of past data.”

They go on to explain, “However, the reported number of jobs funded is not a comprehensive measure of ARRA’s effect on overall employment, or even of those provisions of ARRA for which recipients’ reports are required. The actual impact could, in principle, be significantly larger or smaller than the number of jobs reported.”

So who was right? The economists from the WSJ and IBD made the most accurate predictions, though this doesn’t inherently prove that the stimulus bill was bad, or that it made things worse. The economy does not exist in a vacuum. You cannot plug the same numbers into the same formulas and expect the same results when the economic environment is constantly changing. And there are times that government spending will NOT grow the GDP and create jobs, despite what Keynesians would like you to believe.

Next we’ll discuss the role of government in our economy.

Eldridge Economics Part 1 — Keynesian Economics Insufficient

Tuesday, March 1st, 2011

While Wisconsin politics and union protests dominate the news, there’s still an underlying and equally important story. The economy is struggling. Nothing new about that, but a few stories have recently caught my attention.

1. Supporters of the White House continue to insist that the stimulus bill was effective. Why? Because the CBO says that the bill created millions of jobs. But that’s not really what the CBO said. We’ll come back to this later.

2. New stories have been warning us that budget cuts (from the GOP) will hurt the economy and could send us into another recession.

3. And a twist on this same story, that a government shutdown will hurt the economy. And that hurting a fragile economy could have dire consequences.

All of these stories have a common component — the belief in Keynesian Economics. And whenever you point out the problems with Keynesian Economics, you get blasted as a lover of Trickle Down Economics. Here’s a quote from a conversation I had with some friends on Facebook yesterday: “That trickle you feel is Boehner pissing on your leg and tell(ing) you it’s raining.”

It will take me more than one post to get through some thoughts on the economy. I’m not proclaiming to be an economist. More of an econo-hobbyist. Here’s part one.

John Maynard KeynesKeynesian Economics
I will try not to bore you too much, and keep this as simple as possible. Keynesian Economics advocates a mixed economy, predominantly private sector, but with a large role of government and public sector. And for the most part, the theory is pretty simple. You can read more about it here on Wikipedia.

What we’ll focus on today is what Keynes viewed as the primary reason for a recession, and his recommendations for getting out of a recession. Keynes viewed a recession as a result of shaken consumer confidence that causes consumers to save instead of spend. Excessive savings (beyond typical savings during a normal economy) from consumers slows the exchange of money thus creating the recession.

Keynesian theory recommends stimulating the economy through government spending and/or adjusting the money supply (printing money and/or lowering interest rates). Our federal government has been engaging in increased government spending and expanding the money supply. Keynes was one of the first economists to advocate deficit spending as part of a fiscal policy to cure an economic contraction.

Keynesians believe that if you increase government spending during a recession, what you’re really doing is taking the consumer’s money that they were saving (and not spending due to shaken consumer confidence) and injecting it into the economy. And that every dollar spent in the economy is subject to the “multiplier effect”. Basically, that when a dollar is spent by either the public or private sector, it increases total spending by a multiple of that increase. So when the government spends a dollar, it increases GDP (gross domestic product) by MORE than a dollar. And increases in GDP lead to increases in employment. (This will be important when we discuss the CBO’s statements on the stimulus bill.)

And reversely, if you cut government spending through budget cuts or closing the government, you are reducing GDP, and ultimately reducing employment (increasing unemployment).

Theory vs Reality
I’m not in complete disagreement with Keynes. But more in it’s application. So let’s start with a simple example. Let’s say the multiplier is 2.5 times. So if the government spends $1, we add $2.50 to GDP. If the government spends $800 billion, we add $2 trillion to GDP (that’s $800 billions x 2.5).

So if you subscribe to this theory, you get the same outcome from the stimulus no matter what else is happening in the economy. Does the country have $1 trillion or $14 trillion of debt? Doesn’t matter. Is the federal government imposing thousands of new regulations on the business community or streamlining regulations for business? Is the government viewed as anti-business or pro-business? Doesn’t matter. Do we have strong exports or decades of trade imbalance? Nope, doesn’t matter. Are we importing billions of barrels of oil at $100 per barrel or are we energy independent? Still doesn’t matter.

This theory doesn’t account for the decrease in GDP when an extra dollar is taken out of the private sector. And this theory doesn’t account for the repercussions of borrowing money.

Nothing matters but the multiplier and how much additional money the government injects into the economy.

The problem is that the economy doesn’t exist in a vacuum. There are forces, including other government policies, that are impacting the economy simultaneously. I think it’s entirely possible that in a different economic climate, that the outcome of the stimulus bill could have been considerably different. Or at least viewed differently.

But that will have to wait. Still more topics to cover, and we’ll try to cover them soon. The CBO’s projections. Understanding the deficits. The stimulus package. And what role the government should play in the economy.

Until next time.