Sanders multiplier magic

The critiques of Gerald Friedman's analysis of the Sanders economic plan  continue. The latest and most detailed and careful so far is by David and Christina Romer.

Bottom line:

1. The central idea in Friedman's analysis is that taking $1 from Peter to give to Paul raises overall income by 55 cents.  From this, you get multipliers from raising taxes and spending, from higher minimum wages, more unions, and so forth. 
2. I chuckle a little bit that so many economists who previously liked multipliers now don't like their logical conclusions. 
3. The Romers charge a serious, elementary arithmetic mistake in treating levels vs. growth rates. If they're right Friedman's whole analysis is just wrong on arithmetic.

The analysis

One might have expected that a sympathetic analysis of the Sanders plan would say, look, this is going to cost us a bit of growth, but the fairness and (claimed) better treatment of disadvantaged people are worth it.

Friedman's having none of that. In his analysis, the Sanders plan will also unleash a burst of growth, claims for which would make a fervent supply-sider like Art Laffer blush.

"The Sanders program... will raise the gross domestic product by 37% and per capita income by 33% in 2026; the growth rate of per capita GDP will increase from 1.7% a year to 4.5% a year." And, apparently, raise the growth rate permanently.

More stunning still are Friedman's claims about employment, shown at left here

and here.

Multipliers

So, where does this spurt of growth come from? The answer is the magic of multipliers.

But it's not just run of the mill fiscal stimulus multipliers.  After all, Friedman also says that the Sanders program would reduce the deficit, and by 2025 turn the Federal Budget to surplus!

How are multipliers so strong?

There seem to be two basic answers. First, Sanders assumes that there is a large multiplier from income transfers.

If the government takes $1 from rich Peter, and gives that $1 to poor Paul, overall income rises 55 cents! The one quote that makes this clearest is

The stimulus from regulator[y] changes is in Table 9. In general, the assumption is that wages have a multiplier of 0.9 compared with a multiplier of 0.35 for profits accruing to high-income persons. A wage increase coming out of profits, therefore, has a multiplier of 0.55.

It's also visible here explaining how a balanced budget still has a multiplier

the average value of the (governent spending) multiplier from 2017-26 is 0.89, falling from 1.25 to 0.87 as the output gap closes 

Other taxes are assumed to reduce effective demand with a multiplier of 0.35

[The] balance of revenue and spending programs will increase employment and economic growth because the spending program has a larger fiscal multiplier than do progressive tax increases. 

So tax $1 and spend $1 raises GDP by 54 cents.

He cites many standard sources for multipliers. He does not give a theory.  The standard story is that poor Paul consumes a lot more of his income, while rich Peter was investing it all in venture capital startups.  Consumption is good, savings is bad, so GDP rises.

From this central assumption, the rest of the magic follows.  Friedman creatively goes far beyond conventional deficit multipliers, to conjure multipliers out of tax increases, raises in the minimum wage, greater unionization, increased social program spending, and so forth. For example

 I assume that the Paycheck Fairness Act will raise women’s wages by 1% relative to men’s, and there will be an increase of 0.2% a year for the next decade.  I assume that 50% of the increased cost goes to higher prices and 50% comes from profits, and these are assumed to lower spending by higher income people with a multiplier of 0.35.

This, I think, is the central case. Admire it for its courage, and creative use of Keynesian arguments. These are the kind of interventions that most economists admit reduce growth, but some argue for on other grounds. But in Keynesian economics, taking money from low marginal propensity to consume people, and giving it to high marginal propensity to consume people raises GDP.

Snark

At this point, I stop in a bit of amusement at all the criticism. After all, these are just standard Keynesian arguments. The individual multipliers in Friedman's analysis are all conservative, and cite standard middle-of-the-road sources. The economists now so critical of this analysis, including the Romers, former democratic administration CEA chairs who wrote the open letter from past CEA chairs, and Paul Krugman, have been making big multiplier arguments for years to argue for more spending.  The "new Keynesian" academic literature includes multipliers far above two, so one can point to "science" if you wish. (Gauti Eggertsson, Christiano, Eichenbaum and Rebelo ; a simple example with multipliers as large as you want.)

The Romers are right to emphasize that multipliers only operate where "demand" is slack, and monetary policy doesn't steal the show. But the asterisks about fixed interest rates and output below "capacity" have been overlooked by the mainstream many times before. It's a rare Keynesian economist who ever thinks the economy is operating at full capacity. And Friedman has the former monetary asterisk, and he addresses the latter by claiming a large return to the labor force and increased productivity.

Even that view is not so out of the mainstream. For example,  Brad DeLong and Larry Summers wrote an influential Brookings paper arguing for very large fiscal multipliers, with some of the same flavor. There is hysterisis; a multiplier will bring people back to the labor market (as Friedman claims), those people will regain skills, productivity will increase; higher investment will give us better capital and also increase productivity. Demand creates its own supply.

Friedman is apparently just taking the consumption-first, poor-people-spend-more-than-rich-people, undergraduate ISLM analysis, with a bit of Delong-Summers hysterisis, to its logical conclusion. I agree in a way: take those ideas to their logical conclusion and you get silly propositions (old essay on that). Robbing Peter to pay Paul raises income; wasted government spending is good; theft improves the economy, transfers even from thrifty poor to spendthrift rich improve the economy, hurricanes are good for us, social programs, unions, minimum wages raise GDP, and so forth. Well, if the logical conclusions are patently silly, maybe one shouldn't have been making small versions of those arguments all along. Economic Homeopathy is not wisdom. 

Arithmetic 

But the Romers uncover a deeper puzzle. Even with these assumptions -- government spending multipliers around 0.8, and a transfer multiplier of around 0.55 -- you still don't get the wild increase in growth that Friedman claims. So how does he do it? Their answer: 

We have a conjecture about how Friedman may have incorrectly found such large effects. Suppose one is considering a permanent increase in government spending of 1% of GDP, and suppose one assumes that government spending raises output one-for-one. Then one might be tempted to think that the program would raise output growth each year by a percentage point, and so raise the level of output after a decade by about 10%. In fact, however, in this scenario there is no additional stimulus after the first year. As a result, each year the spending would raise the level of output by 1% relative to what it would have been otherwise, and so the impact on the level of output after a decade would be only 1%.

If this is right, it's absolutely damning. This is a question of arithmetic, not economics. (And I would have to swallow some of my above snark!) 

A clearer (maybe) example: The government spends an extra $1 for one year.  With a 1.0 multiplier GDP goes up $1 that year, period. If the government stops spending next year, GDP goes back to where it was. That's the conventional definition of multiplier, and the one that all Fridman's cited sources have in mind. Per Romers, Friedman misread that calculation and assumed the first $1 of spending raises GDP by $1 forever. In 10 years, you have a multiplier of 10! 

The Romers are cautious, and don't directly make this charge. It's not my job to get into the Hilary vs. Bernie whose-numbers-add-up fight. (At least someone here actually seems to care about numbers and economic plans!) But whether the spreadsheets make this arithmetic mistake or not is an answerable question. I hope to inspire someone with a spreadsheet and a nose for such things to check. This is a great time for a replication exercise! 

(Note: This post has pictures and quotes, which don't translate well when the post is picked up elswhere. If you're not seeing them, come back to the original.)

Update: Joakim Book tries to reproduce the numbers and comes up way short.

Update 2: Justin Wolfers at the New York Times did some old-fashioned journalism: He called up Friedman for a reaction.  The article is great, and clear. Yes, Friedman did the calculation as the Romers allege: An extra dollar of government spending today raises GDP permanently; an extra dollar of permanent government spending raises GDP growth permanently. That is at least not what the cited sources have in mind.

Negative rates and FTPL

I've devoted most of my monetary economics research agenda to the Fiscal Theory of the Price Level in the last two decades (collection here). This theory says, fundamentally, that money has value because the government accepts it for taxes, and inflation is fundamentally a fiscal phenomenon over which central banks' conventional tools -- open market operations trading money for government bonds -- have limited power.

Since I grew up in the 1970s, I figured the FTPL would have its day when inflation unexpectedly broke out, again, and central banks were powerless to stop it. I figured that the spread of interest-paying electronic money would so clearly undermine the foundations of MV=PY that its pleasant stories would be quickly abandoned as no longer relevant.

I may have been  exactly wrong on both points: It seems that uncontrolled disinflation or deflation will be the spark for adoption of FTPL ideas; that the equivalence of money and bonds at zero interest rates,  and central banks powerless to create inflation will be the trigger.

These thoughts are prodded by two pieces in the Economist, "Out of Ammo:" and "Unfamiliar Ways Forward" (HT and interesting discussion by Miles Kimball)

If you want inflation (a big if -- I don't, but let's go with the if) how do you get it? Ultra-low rates, huge bond purchases, and lots of talk (forward guidance, higher inflation targets) seem to have no effect. What can governments actually do?


"Out of ammo" explains

... At least some of them [politicians] have failed to grasp the need to have fiscal and monetary policy operating in concert....

... One such option is to finance public spending (or tax cuts) directly by printing money—known as a “helicopter drop”. Unlike QE, a helicopter drop bypasses banks and financial markets, and puts freshly printed cash straight into people’s pockets. The sheer recklessness of this would, in theory, encourage people to spend the windfall, not save it. 

The "recklessness" part is crucial. "Unfamiliar ways" has a more intricate scheme to communicate that recklessness

..a central bank and its finance ministry ... collude in printing money to pay for public spending (or tax cuts). ...the government announces a tax rebate and issues bonds to finance it, but instead of selling them to private investors swaps them for a deposit with the central bank. The central bank proceeds to cancel the bonds, and the government withdraws the money it has on deposit and gives it to citizens. “Helicopter money” of this sort—named in honour of a parable told by Milton Friedman, a famous economist—is as close as you can get to raining cash from a clear blue sky like manna from heaven, untouched by banks and financial markets.

Such largesse is, in effect, fiscal policy financed by money instead of bonds... But the unaccustomed drama—indeed, the apparent recklessness—of helicopter money could increase the expected inflation rate, encouraging taxpayers to spend rather than save.

Simpler, in my mind, the Treasury borrows and sends checks to voters. The Fed buys the bonds and then cancels them.

In addition to rather convoluted scheme, the pieces are not quite clear why the fiscal counterpart is necessary -- or why money has to be involved with fiscal policy.  That was not a central part of Friedman's helicopters. Miles is clearer about this:

the government give[s] away so much money that people would be convinced there was no way the government could ever sell enough bonds to soak that money up. 

This is clear and good FTPL thinking. The value of money is set by how much there is vs how much people expect the government to soak up via taxes -- or bond sales, backed by credible promises of future taxes.

If the government drops $100 in every voter's pocket but simultaneously announces "austerity" that taxes are going up $100 tomorrow, even helicopter drops would have no effect.

Helicopter drops are a clever fiscal signaling device. Canceling the bonds in the Economists plan is the crucial signaling device. They say "we are really going to be reckless."  When governments sell a lot of bonds, people think  the government is sooner or later going to soak up these bonds with taxes, and do not spend. That's the whole point -- bond sales are set up to raise revenue, not to create inflation.  The whole canceling the bonds thing in the Economists's plan, or the helicopter drama in Friedman's, is a clever psychological device, to convince people that no, the government is not going to raise taxes to soak money or underlying bonds up, so you'd better spend it now before it loses value.

Well if (if) our central banks want inflation, why not get out the helicopters?

Such shenanigans are not possible in the euro zone, where the ECB is forbidden by treaty from buying government bonds directly. Elsewhere they might work as follows: 

monetary financing is prohibited by the treaties underpinning the euro, for example

The US Federal reserve is similarly constrained to always buy something in return for creating money -- it can't send checks to voters.

Why?  The people who set up our monetary systems understood all this very well. Their memories were full of disastrous inflations, and they understood that printing money without clear promises that taxes would eventually soak up that money would lead quickly to inflation. So, yes, central banks are prohibited from doing the one thing that would most quickly produce inflation! For about the same reason that wise parents don't keep the car keys in the liquor cabinet.  (There are also all sorts of good political economy reasons that an independent central bank should not lend to specific businesses or send checks to voters.)

The Economist articles are also quite good at the evidence that current monetary policy is essentially powerless.

If policymakers appear defenceless in the face of a fresh threat to the world economy, it is in part because they have so little to show for their past efforts. The balance-sheets of the rich world’s main central banks have been pumped up to between 20% and 25% of GDP by the successive bouts of QE with which they have injected money into their economies (see chart 1). The Bank of Japan’s assets are a whopping 77% of GDP. Yet inflation has been persistently below the 2% goal that central banks aim for.

The power of open market operations -- buying bonds in return for money - is just dramatically refuted, at least at zero interest rates, by recent experience.

One way to get them back up might be to set a higher inflation target. But when inflation sits so persistently below today’s targets, persuading people that higher targets would produce higher rates will require action, not just words.

Or as I call it, the speak loudly because you have no stick policy. If central banks announce a 5% inflation target, and inflation goes down anyway, now what? Announce a 10% target?

Miles goes on about the power of negative interest rates to stoke inflation, which will be a topic for another day. If negative 2% real rates (2% inflation, 0% interest) didn't stoke "demand" and revive the extinct Phillips curve,  I don't see how negative 3% (2% inflation  -1% interest rate) or negative 5% will finally do the trick. In the standard models I've been playing with,  raising nominal interest rates, and committing to keep them there, is the way for central banks to raise expected inflation. That action would, however, also cool the economy, producing stagflation, and thus be particularly pointless.

I also fully admit that I'm cherry-picking the things I like from the Economist article, and ignoring all sorts of things that seem pretty silly to me. The point: I'm glad to see fiscal-theory thinking making its way out of academic debate into real-world commentary, if only in the "radical ideas" section.  Now, on to the "conventional wisdom" section!

Greece and Taxes

An interview for the Greek Reporter, in English, perhaps cheering the like-minded and sure to infuriate some conventional wisdom.

I agree with the "anti-austerians" on one point: Raising taxes was a bad idea. In my emphasis what counts are marginal tax rates on growth-producing activities, rather than Keynesian pump-priming, however, which is an important distinction.

The article says "A recently released study by the Economics Department at the National Kapodistrian University of Athens revealed that Greece has the third highest taxation rate among 21 European countries." If anyone has a link, especially if it's in English, send it in the comments.

Right Wing NPR

I was listening to NPR this morning over coffee, and nearly spilled it. Host Steve Inskeep was interviewing Mark Surman, Mozilla founder, on the topic of Apple refusing to hand over the keys to the Iphone to the Federal Government (and anyone who might be able to hack the Federal Government. Oh, right, that's never happened!)

INSKEEP: One last thing, coming back to this San Bernardino case, we don't know what's in that iPhone. We don't even know if it's important. But let's spin out the worst case scenario as a prosecutor might. Suppose your side wins, that phone is never opened, and as a result, the government misses a chance to find some other suspect and disrupt some attack. The attack goes forward, and people are killed. Will that have been worth it in order to protect encryption?

Surman, probably flabbergasted that anyone should ask such a question, changed the subject

SURMAN: We need to find ways to really be able to seek communications before they're sent or after they're sent and actually work with law enforcement on doing this well. There are alternative ways to get information, getting access to it before or after it's encrypted. What we want to avoid is creating a precedent where encryption can be broken by an arbitrary third party.

But Inskeep kept at it

INSKEEP: So you're saying, in essence, it may well be harder to catch terrorists, but you can still work at it, and the extra difficulty is worth it.

Remember, this is cloyingly liberal NPR, not some foaming at the mouth right wing program!

Like Surman, I often am too polite to give the right answer to such shocking questions in real time. But with the benefit of hindsight, here's a better answer

COCHRANE: Well, come to think of it, you're right there Steve. And while you're at it, let's keep going. These pesky first and fourth amendments sure get in the way of law enforcement, don't they? I mean all this business about going out and getting warrants, and waiting for a judge is so time consuming. If a terrorist gets away while you're busy getting a warrant, and people are killed, will that really have been worth it to protect some sort of centuries old procedures? If someone stirs up trouble on a Jihadi website, why do we have to allow that? And this annoying business about grand juries, and presenting evidence, and discovery, and Miranda warnings, it's so burdensome. What if some terrorist gets away and kills someone?  The police surely should be allowed to just throw anyone suspicious in jail, to make sure they don't do anything bad. Heck, while you're at it, what's with these prohibitions against torture? Bring back the rack, or start chopping people's fingers off until they talk. If you hold back, and some terrorist kills someone, was your little sense of ethics really worth it?  

There is a reason we have all these protections. There is a reason we need to defend them even in times of turmoil.

Perhaps a President Hillary Clinton will bring a sympathetic ear to the right to digital privacy. She undoubtedly wishes her email had been bullet-proof encrypted, not just from the FBI and NSA, but from the Chinese and Russian hackers likely reading every line.

Update: I realize from some of the comments that the point may not have been clear. This isn't about the Apple decision. It's moot, really, anyway, as even Apple can't open the new Iphones. And one can make cost/benefit arguments either way. My point was about the argument: We will hear quite often in coming years and decades, the argument that even one terrorist caught is worth sacrificing privacy and civil liberty. Be prepared to answer, to point out there are costs as well as benefits, and to list what they are. And, finally, I sound more critical of Inskeep than I should. In fairness, he does not offer an opinion. He asks a question, one commonly asked, and may well have been floating a t-ball in the hope Surman would smash it out of the park as I attempted to do.  Many people will ask that question. It's worth asking, over and over, and rehearsing the answer.

Kashkari on TBTF

Neel Kashkari, the new president of the Minneapolis Fed, is making a splash with a speech about too big to fail, and the need for a deeper and more fundamental reform than Dodd Frank.  I am delighted to hear a Federal Reserve official offering, in public, some of the kinds of thoughts that I and like-minded radicals have been offering for the last few years.

I believe the biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy.

Now is the right time for Congress to consider going further than Dodd-Frank with bold, transformational solutions to solve this problem once and for all.

From an economic point of view, now is indeed the right time -- calm before the storm. I'm not so sure now is a great time from a political view! But perhaps anti-Wall Street feelings from both parties can be harnessed to good use.

...When the technology bubble burst in 2000, it was very painful for Silicon Valley and for technology investors, but it did not represent a systemic risk to our economy. Large banks must similarly be able to make mistakes—even very big mistakes—without requiring taxpayer bailouts and without triggering widespread economic damage.

This is a key lesson. As Dodd-Frank spreads to insurance companies, equity mutual funds, and asset managers, we're losing sight of the idea that trying to stop anyone from ever losing money again is not a wise way to prevent a panic. It's the nature of bank liabilities, not their assets, that is the problem.

I learned in the crisis that determining which firms are systemically important—which are TBTF—depends on economic and financial conditions. In a strong, stable economy, the failure of a given bank might not be systemic. The economy and financial firms and markets might be able to withstand a shock from such a failure without much harm to other institutions or to families and businesses. But in a weak economy with skittish markets, policymakers will be very worried about such a bank failure.

In other words, the whole idea of designating an institution that is per se "systemic" is silly.

...there is no simple formula that defines what is systemic. I wish there were. It requires judgment from policymakers to assess conditions at the time.

Here I think Kashkari isn't really learning the lesson. If it's undefinable, even in words, and needs "judgment," then perhaps the idea really is empty.

More deeply, I think we need to apply much the same thinking to regulation that we do to monetary policy. At least in principle, most analysts think some sort of rule is a good idea for monetary policy. Pure discretion leads to volatility, moral hazard, time-inconsistency and so on. We should start talking about good rules for financial crisis management, not just ever greater power and discretion to follow whatever the "judgment" (whim?) of the moment says.

A second lesson for me from the 2008 crisis is that almost by definition, we won’t see the next crisis coming, and it won’t look like what we might be expecting. If we, or markets, recognized an imbalance in the economy, market participants would likely take action to protect themselves. When I first went to Treasury in 2006, Treasury Secretary Henry Paulson directed his staff to work with financial regulators at the Federal Reserve and the Securities and Exchange Commission to look for what might trigger the next crisis... We looked at a number of scenarios, including an individual large bank running into trouble or a hedge fund suffering large losses, among others. We didn’t consider a nationwide housing downturn. It seems so obvious now, but we didn’t see it, and we were looking. We must assume that policymakers will not foresee future crises, either.

This is an unusual and worthy expression of humility. Others advocate loading up the Fed with "macroprudential" regulation and "bubble pricking" tools, on the faith that this time, yes this time, they really will see it coming, and really will do something about it.  Regulators are not wiser, smarter, less behavioral, etc. than traders.

Speaking of the "resolution authority,"

Unfortunately, I am far more skeptical that these tools will be useful to policymakers in the second scenario of a stressed economic environment. Given the massive externalities on Main Street of large bank failures in terms of lost jobs, lost income and lost wealth, no rational policymaker would risk restructuring large firms and forcing losses on creditors and counterparties using the new tools in a risky environment, let alone in a crisis environment like we experienced in 2008. They will be forced to bail out failing institutions—as we were. We were even forced to support large bank mergers, which helped stabilize the immediate crisis, but that we knew would make TBTF worse in the long term.

There are no atheists in foxholes, the saying goes.  Notice "forcing losses on creditors and counterparties." This is exactly right. "Bailouts" are not about saving the institution, they are about saving its creditors. We should always call them "creditor bailouts." And a run is in full swing, and when the hotlines to the Treasury are buzzing "if we lose money on this, then the world will end," anyone in charge will guarantee the debts.

I believe we must begin this work now and give serious consideration to a range of options, including the following:

• Breaking up large banks into smaller, less connected, less important entities.

Here, Kashkari caused a stir in the press. Bernie Sanders voiced approval. Since "breaking up" has no subject -- who is to do this and how? -- and no mechanism, I'll give Kashkari the benefit of the doubt that he had something more sophisticated in mind than brute force.

• Turning large banks into public utilities by forcing them to hold so much capital that they virtually can’t fail (with regulation akin to that of a nuclear power plant).

Aha! My favorite simple solution, more capital!  I'm delighted to hear it. Of course (to whine a bit), banks don't "hold" capital, they "issue" capital -- it's a liability not an asset. And if they have so much capital that they virtually can't fail, what is this business about public utilities? And why in the world do they need regulation akin to that of a nuclear power plant? Given how regulation has spiraled costs, stultified innovation, and stopped expansion of the one scalable carbon-free energy source we have, that's a particularly unfortunate analogy. Or maybe it's an incredibly accurate analogy for just where Dodd-Frank style regulation will lead. The point is the opposite: with "so much capital that they virtually can't fail" they don't need the hopeless project of "systemic" designation, intensive asset risk regulation, and so forth.

• Taxing leverage throughout the financial system to reduce systemic risks wherever they lie.

A Pigouvian tax on short term debt -- after we get rid of all the subsidies for it -- is my other favorite answer.

The financial sector has lobbied hard to preserve its current structure and thrown up endless objections to fundamental change.

Many of the arguments against adoption of a more transformational solution to the problem of TBTF are that the societal benefits of such financial giants somehow justify the exposure to another financial crisis. I find such arguments unpersuasive.

This needs some explanation. Banks produce studies claiming that higher capital requirements or reduced amounts of run-prone short-term funding will cause them to charge more for loans and reduce economic growth. Kashkari is pointing out that these arguments are pretty thin, because the cost of not doing it is immense -- 10 percent or so of GDP lost for nearly a decade and counting is plausible.

Obviously, I don't agree with everything in the speech. Kashkari is a bit too vague about "contagion" "linkages" and so fort for my taste. But the good news is to have this conversation, and not settle in to implementing page 35,427 of Dodd Frank regulations, head in the sand, while we wait for the next crisis.

The rest of the speech outlines his plans to get the Minneapolis Fed working hard on these issues, and to push for them at the larger Fed. This is a project worth watching.

In case I haven't plugged it about 10 times, my agenda for these issues is in Toward a Run-Free Financial System and the many blog posts under the "banking" "financial reform" and "regulation" labels.

Sad CEA Letter

And just as I was getting all weepy about how great and a-political, obejective, non-partisan and all that the CEA is, along comes an open letter from past CEA chairs Alan Krueger, Austan Goolsbee, Chirstina Romer, and Laura D'Andrea Tyson to Senator Sanders, to restore my cynicism.

The heart of the letter is worthy, and commendable: to call out the fact that Senator Sander's campaign is making promises that don't add up, beyond even the usual stretches of campaign rhetoric from both sides.

But read

 When Republicans have proposed large tax cuts for the wealthy..

Hmm. I wonder if Republicans would characterize their proposals that way? How many speeches have you heard saying "we want  large tax cuts for the wealthy!" No, they say they want tax reform to reduce distorting marginal rates and rampant cronyism.

Really, dear colleagues and friends, how would you respond if Republican CEA chairs were to write a similar letter addressing the shortcomings of Trump's plan that started,

When Democrats have proposed incentive-killing growth-killing marginal tax rate increases with lots of exemptions for their donors... 

and goes on to trumpet their sober-minded analysis of the plans, would you be inspired to plaud their "reputation" for objective evidence-based analysis?

So this is just a poke in the eye, a repetition of partisan Democratic campaign rhetoric, stirring up the base by bulverizing the other party.

Why is Washington so polarized? Because even once-respectable academic economists, transported to Washington, cannot stop themselves from this sort of schoolyard taunting, tribalistic attacks, and repetition of their bosses' propaganda.


Moreover,

For many years, we have worked to make the Democratic Party the party of evidence-based economic policy.

Largely as a result of efforts like these, the Democratic party has rightfully earned a reputation for responsibly estimating the effects of economic policies.

our reputation as the party of responsible arithmetic.

Oh. I thought you were simply doing what all good economists, do, all good CEA chairs do, and you were working to make evidence-based policy a routine feature of all government policy under all administrations. I thought you were working for the benefit of the country, not just the Democratic party.

Worst of all, it's counterproductive. Once you start repeating propaganda -- "tax cuts for the wealthy" -- once you start schoolyard taunts -- the CEA chairs who serve under Republicans are apparently not even capable of arithmetic --  the other side, feeling exactly the intended sling of insult, turns off. You do not gain a reputation for evidence-based policy, you gain a reputation for pandering to political opportunity, and all your "evidence" is immediately suspect of the same partisan bias.

So I don't know in whose eyes the "Democratic party has rightfully earned a reputation for responsibly estimating the effects of economic policies." Among Democrats? Sure. But they often don't care a lot about evidence, as in, say GMO foods or nuclear power. Among Republicans? That's where it might count. I don't go to fancy Republican cocktail parties in DC, but I sort of doubt the chatter goes "well, those Democrats, they have a lot of looney ideas, but you have to hand it to them, they always stick with the science and the evidence."  Evidence is only evidence if it is objective.

So if there ever was such a reputation, you four just threw it away with "large tax cuts for the wealthy" and the insinuation that Republicans can't even add. Instead, you reinforced what I sense your party's reputation actually is among Republicans. And then you're surprised when they don't play nice.

CEA History

The Council of Economic Advisers has released a history of the CEA on its' 70th anniversary, as  Chapter 7 of the  Economic Report of the President. This piece is very interesting for economists interested in policy.

It's a nice reminder on how much economic policy ideas have changed. In the late 1940s, when the CEA was set up, fiscal policy was everything. Solow's growth model had not been invented, let alone Romer's. Monetary policy was a twinkle in Milton Friedman's eye. Adam Smith had more or less been forgotten. Economic policy was widely thought to consist of just setting the right level of fiscal stimulus, let multipliers work their magic, to achieve "full employment" and economic growth. The piece tracks well the rediscovery of microeconomics and regulation, as well as the shifts in macroeconomic thinking.

It reminds us how much the stage has changed. In the early years there were really no economists working elsewhere in government, and there were no think tanks. Now every agency has a chief economist and a staff, and the CEA isn't (!) the only game in town for producing policy-oriented research. Its role has changed as a consequence.

The CEA has long had many roles,  adviser, calculator of numbers, cheerleader for the Administration's policies, spinner for the Sunday talk shows, and interagency warrior.

One of its most important and least appreciated roles is just to stop silly stuff.

Joe Stiglitz:

 the money saved from just one of the many bad projects the CEA had helped stop ... would have been enough to provide us with a permanent endowment

Ben Bernanke, even better:

Economics is a highly sophisticated field of thought that is superb at explaining to policymakers precisely why the choices they made in the past were wrong. About the future, not so much. However, careful economic analysis does have one important benefit, which is that it can help kill ideas that are completely logically inconsistent or wildly at variance with the data. This insight covers at least 90 percent of proposed economic policies.

Some examples

...the Heller Council argued against a proposal during the Kennedy Administration to use nuclear explosives to widen the Panama Canal. In the Nixon Administration, CEA played a leading role in the analysis that led to the conclusion that the government should not subsidize the development of a supersonic transport or SST plane, dubbed the “sure-to-be-subsidized transport” (Schultze 1996). Under President Ronald Reagan, CEA participated in a Gold Commission, which investigated the feasibility of returning to the gold standard, and ultimately advised against doing so. 

In my brief time at CEA while very young I got to see this role up close.  There would be an interagency meeting on something like tariffs and quotas for goose down. Every other agency would show up at a meeting all for it -- defense wants to make sure there are American suppliers of American goose down from patriotic American Geese, so our boys fighting the Russkies in Canada someday will stay warm. The American Goose Down production board is screaming about unfair dumping from China. The Goose Feather Plucker's union is all for it, along with the merchant marine -- under the Jones Act, American geese must travel on American made and staffed ships. State is all for it too, so long as we can carve an exception for special down from Berlin. The Congressional liaison says the Congressman from the one county in the country that makes goose down is screaming about it and will cause all sorts of trouble if we don't do it. And so on and so forth. It was the CEAs lonely role to stick up for the poor consumer who might want a cheap warm jacket. (Note: I'm mostly making all this up as a composite of a large number of different cases.)

There has always been a tension, how much the CEA is there to provide disinterested advice, and how much it is there to cheerlead the Administration's policies, though many of those are at least limited by political considerations, if not downright driven entirely by politics.  Just how much time should the chair spend on Sunday talk shows spinning the latest numbers to show how great the Administration's policies are?

As many commentators and former CEA chairs have observed, there can be a tension between CEA’s duty to advance the President’s agenda and its responsibility to provide expert economic advice. 

Important: You can't be pure and also effective:

CEA chairs and members need to be able to operate effectively within a political environment without it affecting the integrity of their economic advice. 

The Chapter offers good advice, coming from long experience:

Former CEA chairs, members, and staff offer several specific pieces of advice as to how to successfully strike this balance: they advise that CEA should not publicly advocate for policies that are not supported by economic analysis, and that CEA should stick to giving economic advice, not political advice. CEA’s comparative advantage is economics, 

A former chair told me a great story of offering a president political advice, only to be told "you stick to the economics, and let me do the politics."

A big lesson is not to become an administrative agency:

Others advise that the Council should not get too involved in policy coordination. ... One episode that illustrates this lesson occurred during the Johnson Administration, when CEA was responsible for the day-to-day administration of wage-price guideposts to combat inflation.

Stuart Eizenstat, President Carter’s domestic policy adviser, argues that “[t]he CEA cannot provide both detached, Olympian economic advice and become enmeshed in the daily, inter-agency compromises and political log-rolling” (1992).

In 1993, President Clinton created a National Economic Council inside the White House. It seemed to me a sort of parallel CEA. Governments often don't cancel an agency, they just create a new parallel one, and let the old one rot. The report handles this question carefully, but seems to suggest that the arrangement is working, with the NEC allowing the CEA to do less political work and better economic work:

Since 1993, the National Economic Council has been responsible for coordinating economic policymaking. These arrangements have largely served to augment CEA’s effectiveness by permitting it to focus on providing economic advice and analysis and giving the Council greater exposure to the President

The CEA is, rather unabashedly, the representative of the economics profession in the government. The chapter covers it well.

The final function of CEA is to engage with the economics community, by staying abreast of the latest academic research and by sharing new insights with policymakers, and in turn, by communicating the administration’s actions and plans to the economics community. This function helps to support the administration’s efforts to develop economic policies and to articulate and advance the President’s agenda. While the academic character of CEA may not have been originally intended by Congress when it created CEA, this engagement has arguably made the Council a more effective and durable institution.

I'm a little leery of this paragraph. I think the distance from research to policy might productively be a little greater -- let's make sure the latest research is solid first. And the vision that the CEA is there to sell a political agenda to economists is a bit frightening.

But inaugurated by the CEA, there has been a much more active participation by academic economists in policy making. I think policy is better for it -- or at least not as catastrophically bad as it might be otherwise -- and so is academia.  Academics are also taking over from bankers and politicians at the Fed, with positive impact in my view.  Marty Feldstein's box speaks to this issue nicely.

A nice summary:

Many of CEA’s contributions are due to its unique institutional structure: that it is a small organization with no regulatory authority of its own, few direct operational responsibilities, and populated by academic economists. Yet its contributions are also dependent on the ability of its staff to balance operating effectively in a necessarily political environment without being overly influenced by politics, and to be effective in advocating for their positions while providing objective economic advice. All in all, given the divergent objectives reflected in the Employment Act of 1946, CEA’s turbulent early years, and its unusual institutional structure, CEA has proven to be a durable and effective advocate for the public interest.

A small personal note: I got the lucky chance to be a junior staff economist -- basically an RA -- while I was in graduate school. It was a great experience. I worked on a new project every two weeks, largely under Bill Poole. Unlike my academic training, we quickly went from idea, to data, to report or memo and on to the next. Bill taught me a lot. I saw quite a bit of how policy is made. I learned that most of the people in Washington are really smart, hard working, informed, and public spirited. It cured a lot of cynicism.  And it got me to work on much better ideas for my research, to break out of the literature-driven world 3d year graduate students live in, and to make sure my research ideas matter to the larger world.

If you get the chance, go.

An don't worry about politics. At the staff level, it's pretty a-political. In fact, working for an administration whose general philosophy you disagree with would be good for you. (See Martin Feldstein's little essay on this point. Quite a few of the Reagan-era staff were democrats.)

Update: "On February 11, the Hutchins Center on Fiscal and Monetary Policy at Brookings marked this anniversary by examining the ways the CEA and other economists succeed and fail when they set out to advise elected politicians and tap the expertise of some of the “exceptionally qualified” economists who have chaired the Council over the past four decades."

Video and other links here.  And here is their photo from the event, with many past CEA chairs and economists.

Source: Brookings institution. 

Brooks v. Krugman

I usually try to steer away from Presidential politics, and especially from commentators' habit of analyzing character. But last week's New York Times had two particularly interesting columns that invite breaking the rule: "I Miss Barack Obama" by David Brooks and "How America Was Lost" by Paul Krugman.

As we contemplate a Clinton, Sanders, Trump, or Cruz presidency, we may well continue the pattern that each president's main accomplishment is to burnish nostalgia for his (so far) predecessor. Brooks is feeling that.

And he's right. Say what you will about policy, the Obama Administration has, as Brooks points out,  been staffed by people of basic personal integrity and remarkably scandal-free. (In the conventional sense of "scandal." I'm sure some commenters will contend that the bailouts, Lois Lerner, the EPA, and Dodd-Frank and Obamacare are "scandals," but that's not what we're talking about here.) On economic issues, his main advisers have been thoughtful, credentialed, mainstream Democrats. Obama's speeches on many topics have, as David says, been full of "basic humanity," even if one disagrees with his solutions.


Brooks finishes,

No, Obama has not been temperamentally perfect. Too often he’s been disdainful, aloof, resentful and insular. 

Brooks leaves out many faults, including a tendency to hector and demonize opponents and a desire for quick spin successes.  Demonizing opponents is simply ineffective in getting them to see things your way, and has made polarization much worse. Too much short term spin control causes long term damage -- think of the Syrian line in the sand, or the Benghazi cover story.

But recognize what David is doing: Bending over backwards to be nice. Trying to build a  bridge. Finding common ground. Listening. Appreciating an opponent's good intentions and motivations, which lets us move on to craft solutions. Overlooking faults. We'll need a lot of that, and it requires letting festering wounds heal. Because

...there is a tone of ugliness creeping across the world, as democracies retreat, as tribalism mounts, as suspiciousness and authoritarianism take center stage.

Krugman's column is an interesting contrast. It offers a great display of just how our politics got so bad.  It starts well:

How did we get into this mess?

At one level the answer is the ever-widening partisan divide. Polarization has measurably increased in every aspect of American politics, from congressional voting to public opinion, with an especially dramatic rise in “negative partisanship” — distrust of and disdain for the other side.

That would be a terrible thing, wouldn't it. It would be terrible if, for example, people said "distrustful and disdainful" things like

only one of our two major political parties has gone off the deep end.

Polarization and triablism mount when one passes on conspiracy theories and plain untruths. Such as

Democrats don’t routinely deny the legitimacy of presidents from the other party; Republicans did it to both Bill Clinton and Mr. Obama.

"Democrats" have never gone unhinged about who "stole an election," repeating endlessly that President Bush was not legitimate?  It's such a whopper, I don't understand how Krugman thinks his readers (and editors) wouldn't notice it.  Especially given how much coverage Bush v. Gore is getting in the wake of Justice Scalia's death. I can only hope it's a delicious tongue-in-cheek self-parody.

And only a lunatic fringe of Republicans seriously challenged President Obama's legitimacy. Attempting to tar a whole, varied group with a lunatic fringe is a classic demonization tactic.

Or the column's premise:

Republicans have more or less unanimously declared that President Obama has no right even to nominate a replacement for Mr. Scalia

That is also simply factually incorrect. "Republicans" -- not notice tarring  half the population with the subject of the sentence, rather than the potentially correct "some Republican senators" -- are more or less unanimously enamored of one thing, the Constitution. Every statement of every Republican Senator I have read recognizes that the President has every right to nominate a replacement. And they have the right to vote on it. Or not. And all of this is so clearly pre-negotiation posturing it's silly to take seriously anyway.

Krugman's column strikes me therefore as a great example of the polarization process. Right now, the obvious thing for both sides to do is to reach out to find a consensus peacemaker nominee, someone who will preserve the most important parts of what each side wants. Perhaps they could agree to someone who will keep the social advances like gay marriage, abortion rights, and immigration rights, but have a sharper eye to economic freedom and limited government. Such a nominee would be a great capstone for President Obama's term, rather than a bitter fight with a blocked senate. And all sides might be a bit afraid of President Trump/Cruz or Sanders/Clinton making the next nomination at the beginning of a term.

But no, Krugman prefers to assume the fight will be lost and to fulminate in ex-ante demonization:

 The G.O.P.’s new Supreme Court blockade is, fundamentally, in a direct line of descent from the days when Republicans used to call Mr. Clinton “your president.” 

And the Bork nomination, and the Clarence Thomas hearings... well, those never happened.

So Krugman's is a great column in the end. Read it closely and it shows very effectively just what is wrong with our political system: Demonization -- there is good and there is evil, and everything that's wrong comes from the evil side; Mendacity (a good Krugman word) -- passing on known falsehoods; Tribalization -- everything bad comes from "Republicans," a uniform army of orcs.

Brooks ends

Obama radiates an ethos of integrity, humanity, good manners and elegance that I’m beginning to miss, and that I suspect we will all miss a bit, regardless of who replaces him.

Well, at least who replaces him of the current front-runners. Let us hope the electorate wakes up soon to value these characteristics, together with basic competence, in their candidates and in their opinion writers.

The Libertarian Case for Bernie Sanders

The Libertarian Case for Bernie Sanders, from Will Wilkinson at the Niskanen Center. Yes, Denmark scores much above the US on ease of doing business indices. An interesting case. A welfare state is not necessarily a politicized regulatory state, with strong two-way political-industry capture. The latter may be more dangerous economically.  Those who wish to eat golden eggs have an incentive to let the Goose grow fat.

Update: Megan McArdle brilliantly demolishes the case.  "It's fun, but not convincing." My view as well.

Policy Rules Legislation

Allan Meltzer and John Taylor organized a Statement on Policy Rules Legislation signed by quite a few famous economists. John's blog explains in some detail.

Stating a rule or "strategy" about what things the Fed will react to also will help the Fed to pre-commit to things it will not react to. If the Fed says they react to inflation and unemployment, that means you should not expect it to react to stock prices, oil prices, exchange rates, and so forth.

Ms. Yellen's testimony and monetary policy report happen Feb 10 and 11. It will be interesting to hear the discussion of these issues. I hope that discussion includes not just legislation, but whether the Fed should follow something like this strategy communication on its own, in order to limit pressures for the Fed to do unwise things.