Economist Gary Becker – “On the Debt Ceiling” (Becker-Posner Blog)

22 01 2013

A recent post in the Becker-Posner Blog (http://www.becker-posner-blog.com/) features the economic point-counter point discussions of University of Chicago Economist Gary Becker and legal scholar and Federal Judge Richard A. Posner.  A recent post by Gary Becker deals with the issue of the U.S. Debt Ceiling.  Gary Becker’s homepage is found here.

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Following are some excerpts from Gary Becker’s latest post (1/20/2012) titled “On The Debt Ceiling“, posted at the following web address: http://www.becker-posner-blog.com/2013/01/on-the-debt-ceiling-becker.html

On the Debt Ceiling-Becker

Various attempts have been made to introduce rules that limit the aggregate level of federal spending, such as restricting the growth in spending over time to be no greater than the growth in GDP (aside from wartime and other emergencies). Balanced budget proposals do not limit spending per se, but require that enough taxes be raised to cover whatever level of spending passes the legislature and chief executive. However, neither spending limits nor balanced budget rules have ever received enough votes from Congress, although many states and local governments do require a (nominally) balanced budget.
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The “debt ceiling” is much closer to balanced budget rules than to limits on federal spending since it tries to cap the budget deficits that are solely responsible for the growth in debt. As Posner shows, this so-called “ceiling” is not really a ceiling since it can be lifted by a majority vote in both houses of Congress combined with the support of the President. In fact, Congress has raised the ceiling more than 85 times since 1940, and 11 times since 2001.  More economically meaningful ceilings would relate debt to the level of GDP- and perhaps also to interest rates on the debt- since countries with higher incomes and lower interest rates can afford to carry higher debt levels.
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One good reason to have properly defined debt ceilings, even though the President and Congress must approve every piece of spending and taxing legislation, is to force politicians to discuss how this legislation aggregates to produce shortfalls or surpluses between total spending and total tax revenue. Budget deficits are far more common than surpluses in recent decades…..Raising sufficient taxes to cover large and excessive spending would be worse than keeping spending within reasonable bounds while financing some with debt.
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Ultimately, the only way to evaluate debt ceilings is to determine how much they affect the level and composition of spending and taxation. That would not be easy to do in a credible way because of the difficulty in determining the counterfactual; that is, what would have been spending and taxation by the federal government in the absence of the debt ceilings?

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While federal government spending in real terms has grown manyfold since the end of World War II, the ratio of debt subject to the debt limit to GDP was a manageable 57% in the year 2000. This ratio has grown rapidly since then, especially during the past four years, and it is now about 98%, higher than most other rich countries. Clearly, debt ceilings have not prevented spending and taxation from growing significantly over time. Nor would the present ratio of debt to GDP be a big problem as long as interest rates remain low.

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…what counts most for an economy is not the ratio of debt to GDP, but that of government spending to GDP. This ratio will increase or decrease as GDP grows slower or faster than government spending. A decline in this ratio would be achieved if GDP resumes its long-term growth rate of a little over 3% per year, and if the growth in entitlement and other spending were kept under control. It remains to be seen whether the American economy will regain its long-term growth rate, and whether interest groups and politicians will resist the temptation to have government spending continue to grow at a rapid rate.

Graph of Federal Debt: Total Public Debt

Graph of Federal Surplus or Deficit [-]

Graph of Federal Debt: Total Public Debt as Percent of Gross Domestic Product

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Economist Milton Friedman’s View re: Government Action and Economic Liberty (Capitalism and Freedom, 2002)

11 01 2013

In Milton Friedman’s book Capitalism and Freedom (University of Chicago Press, 2002), he addresses the question of ….”How can we benefit from the promise of government while avoiding the threat to freedom?” (pages 2-3)

East-Fork-River-Denali-National-Park-Alaska

 

 

East Fork River, Denali National Park, Alaska, USA

 

Two broad principles embodied in our Constitution give an answer that has preserved our freedom so far, though they have been violated repeatedly in practice while proclaimed in precept.”

First, the scope of government must be limited. Its major function must be to protect our freedom both from the enemies outside our gates and from our fellow-citizens: to preserve law and order, to enforce private contracts, to foster competitive markets.  Beyond this major function, government may enable us at times to accomplish jointly what we would find it more difficult or expensive to accomplish severally.  However, any such use of government is fraught with danger.  We should not and cannot avoid using government in this way.  But there should be a clear and large balance of advantages before we do. By relying primarily on voluntary co-operation and private enterprise, in both economic and other activities, we can insure that the private sector is a check on the powers of the governmental sector and an effective protection of freedom of speech, of religion, and of thought.”

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The second broad principle is that government must be dispersed.  If government is to exercise power, better in the county than in the state, better in the state than in Washington. If I do not like what my local community does, be it in sewage disposal, or zoning, or schools, I can move to another local community, and though few may take this step, the mere possibility acts as a check.  If I do not like what my state does, I can move to another.  If I do not like what Washington imposes, I have few alternative in this world of jealous nations. ”

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The very difficulty of avoiding the enactments of the federal government is of course the great attraction  of centralization to many of its proponents.  It will enable them more effectively, they believe, to legislate programs that – as they see it – are in the interest of the public, whether it be the transfer of income from the rich to the poor or from private to governmental purposes.  The are in the sense right.  But this coin has two sides.  The power to do good is also the power to do harm; those who control the power today may not tomorrow; and more important, what one man regards as good, another may regard as harm. The great tragedy of the drive to centralization, as of the drive to extend the scope of government in general, is that it is mostly led by men of good will who will be the first to rue its consequences.”

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“U.S. Unemployment Rates and FED/Central Bank Policy (Becker on “Becker-Posner” Blog)

22 12 2012

The Becker-Posner Blog (http://www.becker-posner-blog.com/) features the economic point-counter point discussions of Gary Becker and Richard A. Posner.

Gary Becker is University Professor Department of Economics and Sociology Professor, Graduate School of Business at the University of Chicago.  He was awarded the Nobel Memorial Prize in Economic Sciences in 1992 and received the United States Presidential Medal of Freedom in 2007. He is currently a Rose-Marie and Jack R. Anderson senior fellow at Stanford University’s Hoover Institution.  His homepage is found here.

Richard A. Posner is a legal scholar and Federal Judge on the United States Seventh Circuit Court of Appeals, and Senior Lecturer, University of Chicago Law School.  His home page is found here.

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Following is and excerpt from Gary Becker’s latest post (12/16/2012) on “The Unemployment Rate and Central Bank Policy“, posted at the following web address:

http://www.becker-posner-blog.com/2012/12/the-unemployment-rate-and-central-bank-policy-becker.html

The Unemployment Rate and Central Bank Policy-Becker

Low inflation and “full” employment have been statutory goals of the Federal Reserve for the past 35 years. Often, however, inflation received the most attention, as when former Fed chairman Paul Volcker in the early 1980s sharply raised interest rates and put the economy in recession in order to wring inflationary expectations out of the system.

On December 12th, Ben Bernanke, the chairman of the Fed, indicated that the Fed would pursue what one might think is simply a variant of the full employment target by keeping nominal interest rates close to zero until the US unemployment rate dips below 6.5%-it is currently 7.7%- or until inflation is forecast to exceed 2.5%. The challenge facing this proposal is that while an unemployment rate target may seem to be just the flip side of the full employment target, unemployment can be nudged by other government policies in ways that have little effect on employment.

The present high level of unemployment in the US in good measure reflects the slow rate of recovery of real GDP and employment from its recession levels. According to “Okun’s Law”, the recovery in employment from a recession is simply related to the recovery in real GDP (see the discussion of Okun’s Law in my blog post on 11/4/2012). Okun’s Law implies that a central bank can use the recovery in real GDP as a proxy for the recovery in employment toward a full employment goal.

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The complication is that changes in unemployment rates during business cycles are not just mirror images of changes in employment rates. This has been especially the case during the Great Recession. By definition, the unemployed equals the difference between the number of persons in the labor force and the number of persons working. The unemployment rate is then defined as the number of individuals who are unemployed as a fraction of the labor force. It follows from the definition of unemployment that the unemployment rate equals one minus the employment rate (the ratio of the number of persons employed to the number of persons in the labor force). This relation shows that changes in the unemployment rate would be equal to but opposite in sign to changes in the employment rate only as long as the labor force remained fixed.

During business cycles, the employment rate and the unemployment rate do move in opposite directions, but the relation is far from one to one, especially during severe recessions. The reason is that the labor force also changes over the course of a business cycle. Especially during severe recessions, some workers get discouraged about finding jobs and leave the labor force. This would tend artificially to reduce the unemployment rate even when both employment and unemployment did not change. This is why the official unemployment rate is usually supplemented with measures of the “total” unemployment rate that include both individuals who got discouraged and withdraw from the labor force, as well as those working part time because they could not find full time jobs. This total unemployment rate now stands at 14.4%, much above the 7.7% official rate.

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The unemployment rate is also affected by policies that affect eligibility for unemployment compensation, such as the extension of unemployment benefits during this recession to 99 weeks. Such an extension increases unemployment because it encourages individuals to become or remain unemployed in order to collect unemployment benefits for a longer time. The net effect of extensions in unemployment benefits is to increase the unemployment rate differently from any decline in the employment rate.

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A major risk of trying to implement an unemployment target through present Fed policies is that the inflation rate could increase in a futile attempt to bring down further the unemployment rate to a targeted rate, as happened in the 1970s. To its credit, the Fed protected against this possibility by setting its target at a relatively high unemployment rate of 6.5%, even though the rate prior to the onset of the recession in 2007 was well under 5%. The Fed also directly faced the risk of creating excessive inflation by setting its target as no more than 6.5% unemployment only as long as the inflation rate does not rise about 2.5%, a modest rate of inflation.





“The Role of Prices” in a Free Market from ‘Free to Choose’ (Friedman, 1980)

29 11 2012

In their book “Free to Choose: A Personal Statement” (published by Harcourt Brace Jovanovich, Inc. 1980) authors Milton and Rose Friedman address the role of prices in a promoting the efficient use of a society’s resources.

Following of some quotes from Chapter 1 – The Power of the Market (pages 9-37) that are particularly relevant in today’s economic environment:

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On the relative merits of “voluntary cooperation” as opposed to “command” economic systems….

“Just as no society operates entirely on command principle, so none operates entirely through voluntary cooperation. Every society has some command elements. These take many forms.  They may be as straightforward as military conscription or forbidding the purchase and sale of heroin or cyclamates or court orders to named defendants to desist from or perform specified actions.” (page 11)

“It makes a vast difference what the mix is – whether voluntary exchange is primarily a clandestime activity that flourishes because of the rigidities of a dominant command element, or whether voluntary exchange is the dominant principle of organization.” (page 11)

“A predominantly voluntary exchange economy …. has within it the potential to promote both prosperity and human freedom. It may not achieve its potential in either respect, but we know of no society that has ever achieved prosperity and freedom unless voluntary exchange has been a dominant principle of organization.” (page 11).  

The authors go on to say that “voluntary exchange is not a sufficient condition for (personal and economic) prosperity and freedom”, but that it is a necessary condition.

THE ROLE OF PRICES (beginning on page 13)

“The key insight of Adam Smith’s Wealth of Nations is misleadingly simple: if an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it.  Most economic fallacies derive from the neglect of this simple insight, from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.” (page 13)

“Adam Smith’s flash of genius was his recognition that the prices that emerged from voluntary transactions between buyers and sellers – in short, in a free market – could coordinate the activity of millions of people, each seeking his own interest, in such a way as to make everyone better off.  It was a startling idea then, and it remains one today, that economic order can emerge as an unintended consequence of the actions of many people, each seeking his own interest.” (pages 13-14)

Prices perform three functions in organizing economic activity: first, they transmit information; second, they provide an incentive to adopt those methods of production that are least costly and thereby use available resources for the most highly valued purposes; third, they determine who gets how much of the product-the distribution of income. These three functions are closely interrelated.” (page 14)

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The accompanying 10 part PBS TV Series titled “Free to Choose” involving Milton Friedman can be accessed at the following website: http://miltonfriedman.blogspot.com/





Guidance from Friedman’s “Capitalism and Freedom” (with commentary)

22 11 2012

In the preface to Milton & Rose Friedman’s book “Free to Choose” (Harcourt Brace, Jonanovich Publishers, 1980), reference is made to the Friedman’s earlier book “Capitalism and Freedom”.

Capitalism and Freedom examines “the role of competitive capitalism – the organization of the bulk of economic activity through private enterprise operating in a free market – as a system of economic freedom and a necessary condition for political freedom.” In the process, it defines the role that government should play in a free society.

“Our principles offer,” Capitalism and Freedom says, “no hard and fast line how far it is appropriate to use government to accomplish jointly what it is difficult or impossible for us to accomplish separately through strictly voluntary exchange.  In any particular case of proposed intervention, we must make up a balance sheet, listing separately the advantages and disadvantages.  Our principles tell us what items to put on one side and what items on the other and they give us some basis for attaching importance to different items.”

The Friedman’s are being diplomatic and circumspect in providing such advice – calling on people to look carefully at both the costs and benefits of government involvement in the functions of resource allocation markets.

In recent years rapid expansion in U.S. government regulatory oversight and in some cases inhibiting interference with the functions of free market resource allocation has occurred in a number of sectors of the U.S. economy, such as the healthcare system, energy production, automobile production, and the financial / futures industries.  Furthermore, proposed increases in regulation of agricultural production systems and consumer’s food and dietary choices are also being considered by U.S. government agencies.

As governmental dictates interfere with free market resource allocation, history shows that poorer U.S. economic performance, fewer and poorer employment opportunities, and a lower economic standard of living are the near assured end result.  Governments – no matter their good intentions to correct economic and social wrongs – do a poor job of allocating scarce economic resources in comparison to free markets.

As we go through the works of Milton Friedman, Thomas Sowell, Friedrich Hayek, and other free market-oriented economists on this blog, the economic damage to efficient allocation of economic resources by over-regulating government actions will be a primary topic of analysis and discussion.





KC Fed Financial Stress Index => Still low U.S. Financial Stress in October 2012

15 11 2012

The Kansas City Federal Reserve calculates a monthly Financial Stress Index (here).  See the following description to by the KC Fed of the KCFSI….

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KC Fed – Financial Stress Index

The Kansas City Financial Stress Index (KCFSI) is a monthly measure of stress in the U.S. financial system based on 11 financial market variables.

A positive value indicates that financial stress is above the long-run average, while a negative value signifies that financial stress is below the long-run average. Another useful way to assess the current level of financial stress is to compare the index to its value during past, widely recognized episodes of financial stress.

How should the index be interpreted? The KCFSI is constructed to have a mean value of zero and a standard deviation of one. A positive value of the KCSFI indicates that financial stress is above the longrun average, while a negative value signifies that financial stress is below the long-run average. A useful way to assess the level of financial stress is to compare the index in the current month to the index during a previous episode of financial stress, such as October 2008.

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The most recent KCFSI report for October is available at the following web address, with exerpts from the report to follow:

http://www.kansascityfed.org/publicat/research/indicatorsdata/KCFSI/kcfsi.oct.2012.pdf

“The Kansas City Financial Stress Index (KCFSI) continues to indicate that financial stress remains low. The KCFSI measured -0.40 in October, a slight increase from September’s value but below its long-run average. This is the first increase in the KCFSI since May 2012.”

Comment by Daniel O’Brien – blog author:

These numbers seem to indicate that the U.S. economy is not in extreme financial stress in the fall of 2012 to the degree that it was in the fall of 2008.  These findings suggest that although serious financial issues are facing the U.S. economy and the U.S. consumer, at this time the U.S. is not experiencing a period of extreme financial stress.  If one political party in the U.S. was basing its 2012 election campaign on jobs and economic growth potential being lost, it may just be that some significant numbers of swing voters among the American public at large was not feeling or perceiving enough personal, kitchen table level economic stress to motivate them to change the party in presidential power.