Reason Magazine Article Examining the Pro-Government Expenditure Bent of Many Macroeconomic Models

18 05 2011

Veronique de Rugy, from the June 2011 issue of Reason Magazine (http://reason.com/) writes an article titled “Ugly Modeling…Will spending cuts ruin or improve America’s economy?” which can be found at the following web address:
http://reason.com/archives/2011/05/10/ugly-modeling.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University (http://mercatus.org/veronique-de-rugy?id=17018).

The author touches on issue relating to Keynesian theory and assumed economic multipliers for government expenditures…

“Also, the Zandi and Phillips models are based on the Keynesian view that government spending produces recovery. According to that theory, $1 in government spending produces substantially more than $1 in growth, a phenomenon known as the “multiplier effect.” The Goldman Sachs study assumes a multiplier greater than three—i.e., more than $3 in additional GDP for each dollar of government spending. But a review of the empirical literature reveals that in most cases a dollar in government spending produces less than a dollar in economic growth. And these findings often don’t even take into account the impact of paying for that government dollar via increased taxes.”

“The Harvard economists Robert Barro and Charles Redlick estimate that the multiplier for stimulus spending is between 0.4 and 0.7. In another study, the Stanford economists John Taylor and John Cogan concluded that the stimulus package couldn’t have had a multiplier much greater than zero. Even the multipliers used by Christina Romer, the former chairwoman of the White House Council of Economic Advisers, and Jared Bernstein, economic adviser to Vice President Joseph Biden, in their January 2009 paper “The Job Impact of the American Recovery and Reinvestment Plan,” ranged from 1.05 to 1.55 for the output effect of government purchases. More recently, the Dartmouth economists James Feyrer and Bruce Sacerdote, who supported the stimulus, acknowledged that it didn’t boost the economy nearly as much as the administration models claimed it would.”

The author’s final thoughts and prescriptions for the economy are as follows…

“Now what? Many economists and many members of the business community argue that recent policy changes have hampered investment, making a bad situation worse. The prospect of endless future deficits and accumulating debt raises the threats of increased taxes and of government borrowing crowding out capital markets, diverting resources that could be used more productively. As a result, U.S. companies are less likely to build new plants, conduct research, and hire people.”

We have tried spending a lot of money to jump-start the economy, and it has failed. Now we need to cut spending and lift the uncertainty paralyzing economic activity. That approach will not just be more fiscally responsible. It will also empower individuals and entrepreneurs. And they are the only ones who can bring on a real recovery.”

In economics there is much debate and division into camps of thought regarding which schools of economic thought and theory best represent the functioning and processes involved in macro-economies.  It is difficult to change one’s mind about a school of economic theory that we have invested time, blood, sweat, tears, and even our careers in.  Yet, the Keynesian models are failing to accurately represent the stimulative impact of government expenditures upon the U.S. economy.  To keep following these failed theories will lead to long term economic damage for the U.S. and World economy.


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“A Decade of Debt” by Reinhart and Rogoff: Trends toward “Financial Repression” of Economic Activity

15 05 2011

On March 28, 2011 macroeconomists Carmen Reinhart (bio) and Kenneth Rogoff (bio) recently made available a paper titled “A Decade of Debt” addressing the track record of the impact of major increases in public indebtedness upon various countries economic performance in recent history.  The paper is published as a discussion paper on VoxEU.org (http://globalcrisisdebate.info/), which is “a policy portal set up by the Centre for Economic Policy Research (www.CEPR.org) in conjunction with a consortium of national sites.”

“A Decade of Debt” provides a sobering and objective analysis of a) how public and private indebtedness has affected world economies in recent history (i.e., Japan, Iceland), and b) the impacts that current public indebtedness in the United States and elsewhere can be expected to have in the next decade.  Following is the web reference to obtain a free pdf of the paper (http://globalcrisisdebate.info/index.php?q=node/6295) as well as the paper’s abstract…..

Abstract of “A Decade of Debt” by Reinhart & Rogoff

This paper presents evidence that public debts in the advanced economies have surged in recent years to levels not recorded since the end of World War II, surpassing the heights reached during the First World War and the Great Depression. At the same time, private debt levels, particularly those of financial institutions and households, are in uncharted territory and are (in varying degrees) a contingent liability of the public sector in many countries. Historically, high leverage episodes have been associated with slower economic growth and a higher incidence of default or, more generally, restructuring of public and private debts. A more subtle form of debt restructuring in the guise of “financial repression” (which had its heyday during the tightly regulated Bretton Woods system) also importantly facilitated sharper and more rapid debt reduction than would have otherwise been the case from the late 1940s to the 1970s. It is conjectured here that the pressing needs of governments to reduce debt rollover risks and curb rising interest expenditures in light of the substantial debt overhang (combined with the widespread “official aversion” to explicit restructuring) are leading to a revival of financial repression–including more directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, and tighter regulation on cross-border capital movements.

A few of the key points from the paper:

1) “The combination of high and climbing public debts (a rising share of which is held by major central banks) and the protracted process of private deleveraging makes it likely that the ten years from 2008 to 2017 will be aptly described as a decade of debt.”

2) “Historically, high leverage episodes have been associated with slower economic growth.”

3) Surges in private debt lead to private defaults (which most often become manifest in the form of banking crises). Banking crises are associated with mounting public debt, which ultimately lead to a higher incidence of sovereign default or, more generally, restructuring of public and private debts. Specifically, banking crises and surges in public debt help to “predict” sovereign debt crises.

4) “It is conjectured here that the pressing needs of governments to reduce debt rollover risks and curb rising interest expenditures in light of the substantial debt overhang, combined with an aversion to more explicit restructuring, may lead to a revival of financial repression. This includes more directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, and tighter regulation on cross-border capital movements.”

There is much to think about and digest in regards to Reinhart and Rogoff’s work. In future posts I will review parts of their paper.  This paper can provide some sober-minded, fact based objectivity for serious citizens to think about concerning the debt issues now being wrestled with by the United States.





Mises Daily Blog: Macro Confusion: Inflation, Commodities and the Fed

12 05 2011

On the Von Mises Institute Daily index is an article by Kel Kelly dated May 12, 2011 on general macroeconomic misunderstanding of the root causes of our current economic situation.  The article can be found at the following web reference:

http://mises.org/daily/5273/Macro-Confusion-Inflation-Commodities-and-the-Fed

Following are a few key sections that are particularly relevant to today’s concerns about commodity price inflation and the role or economic impacts of monetary actions by the U.S. Federal Reserve bank.

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Will the Fed Raise Rates?

The discussion began with CNBC’s in-house economist Steve Liesman discussing whether the Fed should raise rates in response to reports of soaring wholesale inflation numbers. He explains that the Fed “has so far concluded that it would be the wrong medicine right now for the problem.”

That alone brings us the first concern: It is difficult to imagine that the Fed has actively decided not to raise rates, when the fact is that — as things stand — it could not raise rates even if it wanted to (and it might want to). It can raise treasury rates by ceasing to buy treasuries, but it can’t raise the federal-funds rate.

The Fed raises the federal-funds rate via open-market operations that withdraw money from the federal-funds market, making money more expensive. But given the massive amount of excess reserves that the banks hold at the Fed, it is virtually impossible for the Fed to withdraw all the reserves it has created without causing massive economic damage. Therefore, it is the excess money on the market that is keeping rates near zero. Thus, the banks — not the Fed — are in charge of interest rates.

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Regarding the root cause of commodity price inflation, Kelly writes…

But the demand for commodities and the prices of other goods have not been falling. Why? Because what is driving up commodity prices — while the prices of all other goods are rising at the same time — is simply an increase in the quantity of money. Market participants are bidding up the price of commodities, along with consumer goods and stock and bond prices (and, formerly, real-estate prices) with the additional money they are receiving from the central bank.

Rising asset prices are the manifestation of inflation. The prices of financial instruments and commodities are rising more rapidly than consumer prices because they are traded on exchanges, where banks, insurance companies, hedge funds, and the like insert funds newly borrowed at cheap rates from the world’s central banks. Further, foreign central banks themselves redirect reserves earned from the US trade deficit into the financial markets. Therefore, new money flows disproportionately into the asset markets relative to the real economy.

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Regarding Fed policies and the impact on commodity prices….

The Fed officials are saying that if they raise interest rates and/or reduce money supply growth, the economy will slow. They are therefore saying that the economy is being driven — or at least pushed along — by low rates and by money and credit “being available” (as they would say). Therefore, the growing economy, in their view, causes a “demand” for commodities. They don’t say that it is a monetary demand — just a general “demand.”But they also acknowledge that if this demand were reduced with “monetary policy tools,” demand for commodities would fall. Thus, they are simultaneously saying that their policies are not driving commodities prices higher, but that if they undo their policies, commodities prices will fall. The fact is that it is their money pumping that is driving both GDP growth and commodities prices — but not the real economy.

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All this is food for thought in regards to the impact of Fed policies based on Keynesian economic theory on commodity price inflation – as we have seen both ups and downs in recent weeks and months.





Austrian Economist Friedrich A. Hayek – one whose ideas we should look to

1 05 2011

Friedrich August Hayek (1899-1992 )

The Concise Encyclopedia of Economics at the online Library of Liberty and Economics (http://www.econlib.org/index.html) provides a thumbnail sketch of economist Friedrich A. Hayek (see http://www.econlib.org/library/Enc/bios/Hayek.html).  Following are some key excerpts from their article, with my own emphasis on issues relevant to today’s economic issues of government involvement in trying to manipulate and manage economies, of inflation, and of the roles and economic impacts of the U.S. Federal Reserve system ….

“Most of Hayek’s work from the 1920s through the 1930s was in the Austrian theory of business cycles, capital theory, and monetary theory. Hayek saw a connection among all three. The major problem for any economy, he argued, is how people’s actions are coordinated. He noticed, as Adam Smith had, that the price system—free markets—did a remarkable job of coordinating people’s actions, even though that coordination was not part of anyone’s intent. The market, said Hayek, was a spontaneous order. By spontaneous Hayek meant unplanned—the market was not designed by anyone but evolved slowly as the result of human actions. But the market does not work perfectly. What causes the market, asked Hayek, to fail to coordinate people’s plans, so that at times large numbers of people are unemployed?

One cause, he said, was increases in the money supply by the central bank. Such increases, he argued in Prices and Production, would drive down interest rates, making credit artificially cheap. Businessmen would then make capital investments that they would not have made had they understood that they were getting a distorted price signal from the credit market. But capital investments are not homogeneous. Long-term investments are more sensitive to interest rates than short-term ones, just as long-term bonds are more interest-sensitive than treasury bills. Therefore, he concluded, artificially low interest rates not only cause investment to be artificially high, but also cause “malinvestment”—too much investment in long-term projects relative to short-term ones, and the boom turns into a bust. Hayek saw the bust as a healthy and necessary readjustment. The way to avoid the busts, he argued, is to avoid the booms that cause them.

Regarding the causes of inflation, and how central banks were at least partly responsible for inflationary pressures by their Keynesian-like  economic policies and actions, note the following….

Hayek believed that Keynesian policies to combat unemployment would inevitably cause inflation, and that to keep unemployment low, the central bank would have to increase the money supply faster and faster, causing inflation to get higher and higher. Hayek’s thought, which he expressed as early as 1958, is now accepted by mainstream economists (see the Phillips Curve).”

Hayek penned the book The Road to Serfdom (http://en.wikipedia.org/wiki/The_Road_to_Serfdom) in which be gave a withering critique of socialist-oriented government control of economies. Quoting from Wikipedia…..

“….(Hayek) warned of the danger of tyranny that inevitably results from government control of economic decision-making through central planning, and in which he argues that the abandonment of individualism, liberalism, and freedom inevitably leads to socialist or fascist oppression and tyranny and the serfdom of the individual. Significantly, Hayek challenged the general view among British academics that fascism was a capitalist reaction against socialism, instead arguing that fascism and socialism had common roots in central economic planning and the power of the state over the individual.”

The ideas and philosophies of Hayek would be identified today by many as either classical liberalism (http://en.wikipedia.org/wiki/Classical_liberalism) or libertarianism (http://en.wikipedia.org/wiki/Libertarianism), although many political and economic conservatives would be in strong agreement with much of what Hayek espoused.