Christina and David Romer on the Sanders plan

by on February 25, 2016 at 6:34 pm in Current Affairs, Economics | Permalink

They have produced a systematic critique of the overly optimistic projections (pdf):

…standard indicators of slack suggest that the output gap is currently no more than moderate. The unemployment rate, at 4.9%, is at normal levels. A broader measure of unemployment (the “U-6” measure) is just 2 percentage points above its low point before the 2008 recession. The Federal Reserve index of capacity utilization is about 4 percentage points below its pre-recession level. Job vacancies, which one would expect to be low with vast slack, are above their pre-recession levels.  And inflation, which one would expect to fall in an economy operating far below capacity, is flat or perhaps creeping slightly upward.  None of this is remotely consistent with a shortfall of output from capacity of even 10%, much less the amount that would be needed to accommodate Friedman’s estimate that the Sanders policies would raise output in 2026 37% above the CBO forecast.

There is much more at the link.  For the pointer I thank many people in my Twitter feed, including Austan Goolsbee.

1 Joël February 25, 2016 at 7:04 pm

It is not a critical analysis of the Sanders plan, but of Friedman’s analysis. Friedman does not work for Sanders, and Sanders did not quote Friedman’s analysis in any of his speech, nor in any debates, nor did he put it on his campaign site. Friedman’s analysis is ridiculous. Sanders plan is radical and perhaps dangerous, but anything is better than Clinton, and don’t count on Trump to defeat her.

2 coketown February 25, 2016 at 7:14 pm

WaPo says Friedman consulted directly with the Sanders campaign when writing his analysis, so it’s likely any critique of Friedman’s analysis is pertinent to Sanders’ agenda.

3 Alex February 25, 2016 at 8:04 pm

Clinton is the best candidate, except maybe Trump-we’ll have to see his advisors first.

4 Stuart February 25, 2016 at 8:20 pm

Do you think Trump wins the vote of many Latinos/Asian-Americans? If yes, how, and if not, how can a GOP candidate win without doing well with those demographics?

5 Dzhaughn February 25, 2016 at 9:16 pm

Um, actually, some of us think of winning in terms of better or worse governance.

6 cowboydroid February 25, 2016 at 11:00 pm

There are always worse options.

But presidential campaigns are like choosing between a rotten banana and a piece of poop.

7 Dan Weber February 26, 2016 at 11:31 am

Right. I don’t like Clinton, but this election cycle is the perfect example of “there is always someone worse.”

8 anon February 25, 2016 at 7:17 pm

I like Nordic systems. Maybe I should choose a bad spokesman for that path over actual opponents. Details can be filled in later.

Sort of like Cain’s 9-9-9

http://www.cnn.com/2015/10/10/politics/donald-trump-herman-cain-black-pastors/

9 Dzhaughn February 25, 2016 at 9:17 pm

Or perhaps you should support a ruinous Trump administration in order to destroy the right wing once and for all.

10 anon February 26, 2016 at 8:47 am

Some are making the argument that the Republican Party, as we knew it, is over. It’s possible, and that many are too caught up in the election to notice.

11 rayward February 25, 2016 at 7:19 pm

Compared to what? The Trump plan? The Cruz Plan? The Rubio plan? All of which repeat the George W. Bush plan. How did that turn out? Owners of capital, whether as investor or as taxpayer, abjure investment in productive capital and public infrastructure, preferring instead to speculate in real estate and financial assets. Investment in productive capital and infrastructure are what create jobs and economic growth while speculation in real estate and financial assets produce short-term profits, bubbles, and financial and economic instability. We know what results from the George W. Bush plan.

12 Anton February 25, 2016 at 7:27 pm

We’re the “reality-based community,” remember? I don’t think we should consider the Bush administration (or Trump or Cruz or whoever) to be the standard of intellectual rigor we should aspire to.

13 Alai. February 25, 2016 at 9:44 pm

Further, Bush was responsible for a large portion of the recovery with the energy policy act of 2005.

14 cowboydroid February 25, 2016 at 11:03 pm

So you’re saying there are no good choices.

Isn’t that the definitive nature of the political market?

15 MC February 25, 2016 at 11:38 pm

Did all of those other countries around the world (many of whose leaders hated GWB) copy GWB’s economic plan to produce their real estate bubbles?

16 Rich Berger February 25, 2016 at 7:48 pm

So these economists are providing a serious critique of a fantasy? Ha-ha-ha!

17 Harun February 25, 2016 at 9:16 pm

Romer’s estimates were so correct last time.

p.s. Will Austan Goolsbee be leaking Trump’s tax returns this election?

18 msgkings February 26, 2016 at 1:02 am

It’ll be interesting to see if Trump says ‘f*** you I’m not showing my returns’ even if nominated. Seems like his style.

19 Boonton February 26, 2016 at 6:14 am

I agree with previous comments here. As an ‘unrealistic projection’ this strikes me as remarkably mature for someone running for office. Does anyone even try to analyze Republican projections anymore? What are they? 40% growth per year from Donald making ‘buddah deals’ with China and Mexico? Health care gets so cheap you don’t need to buy insurance by malpractice reform? No unemployment if the estate tax is eliminated?

20 glasnost February 26, 2016 at 9:43 am

This does far more to validate the Sanders plan than it does to tear it down. Christina Romer is acknowledging the validity of the basic mechanisms of Friedman’s analysis, and haggling over details over exactly how big the effect will be. Who really gives a damn if it creates 5% growth or 4%?

Some examples:

“Second, in assuming that demand stimulus can raise output 37% over the next
10 years relative to the Congressional Budget Office’s baseline forecast,
Friedman is implicitly assuming that the U.S. economy is (and will continue to
be for a long time) dramatically below its productive capacity. However, while
some output gap likely still exists, the plausible range for the output
gap is much too small to accommodate demand effects nearly as
large as Friedman finds. ”

Not only is the detailed analysis wholly unconvincing, but this is haggling over size of effect, not direction. It’s highly uncertain. Let’s look at examples:

“The view that the employment-to-population ratio
as of 2000 represents normal employment that can be achieved solely through demand
expansion (and that it will continue to do so for the next decade) implies that the economy had
substantial slack even before the Great Recession, that none of the fall in the ratio since 2007
reflects long-run factors, and that demographic changes will exert no downward pressure on the
ratio over the next decade. ”

The economy had substantial slack before the Great Recession – gee you really fucking think so? Overwhelmingly obvious to real people. Demographics and long-run factors – it’s not a law of nature that old people can’t work if you set the reward high enough folks, and *of course* it’s due to long-run factors – a long-run factor called “long-run lack of demand due to stagnating and falling income among people who actually spend money consumption” – i.e. the very factor that this plan *attacks*.

Footnote 18:

“It is well known that in the short run, a demand-driven boom raises measured productivity, through
such channels as firms using their workers more intensively and moving them from activities like deferred
maintenance to production. But the scope for such changes is limited, and thus they could not lead to
sustained high productivity growth in response to a large, long-lasting demand expansion. ”

Romer has no idea how large these channels are. In the midst of a gigantic demand slump lasting 15+ years, with historically high levels of capital sitting on the sidelines, waiting for a signal, they seem pretty damn high to me. On the basis of “look at these experts” and historical precedent, she’s sure the output gap isn’t this big. But seriously, nobody knows.

Furthermore, in a world of digital goods, productivity almost doesn’t measure anything *except* demand. The idea that it measures efficiency has never been weaker. There’s no upper limit on digital production; it requires virtually no additional physical capital or additional labor, even intellectual. Output is whatever demand wants it to be. The production ceiling, as measured, is near-infinite.

To return to the beginning, this is an actual plan for raising productivity growth via the fiscal channel, the kind of stuff the monetarists are begging for, and the response of the technocrats is to shoot it down on sight for maybe being optimistic in the size of the unknown-size effects, whose basic mechanisms they end up endorsing? Jesus Christ, liberals in a foxhole.

21 Boonton February 26, 2016 at 10:49 am

Excellent analysis.

Let’s also add this, all plans are dynamic. If you implemented fiscal stimulus and all in the sudden you found that the labor force participation rate would not go up, inflation and long term interest rates started to pick up…that would be a clear indication that the amount of potential slack in the economy has been exhausted.

Since it is ultimately a guess if the current economy is ‘normal’ or has lots of slack, it seems like it would be very sensible to test and push the economy to see if we can find a limit that is better than what it is now. Instead many intellectuals here are more inclined to spin out reasons for thinking the status quo is the ‘new normal’. Perhaps it is but shouldn’t we try to find out for sure?

22 Robert Bostick February 29, 2016 at 4:14 pm

Excellent reply. In my view anyone relying on CBO assumptions to forecast economic growth is disqualified from from the discussion. CBO, wrongly assumes the Federal Government (being monetarily sovereign) needs revenue to spend and, therefore, is constrained by the lack of such revenue. Friedman, by the same token assumes, a real redistribution effect from higher tax rates on the 1%. Taxes are not recycled, saved, or used in any way to pay for anything. All taxes collections are destroyed once the I.O.U. http://goo.gl/Ak7Dfy liability is satisfied. Our Federal Government never keeps something that says “I owe myself a dollar’s worth of tax credits.”

Relying on CBO assumptions based on gold standard rubrics is the failure of both the Friedman analysis and the Romer Critique.

23 B.B. February 26, 2016 at 12:32 pm

I don’t want a political argument, which seems pointless anyway.

The pure economics interests me. Let say the Romers are right about Sanders. And the Sanders plan wins anyway.

The Romers say that Sanders wants a large deficit-financed increase in government spending, plus minimum wage hikes. They say that such a plan would quickly exhaust the leftover slack in the US economy and then some. The US would have excess aggregate demand, and inflation would rise. The Fed would have to raise interest rates to hit its inflation target. (Would Bernie raise the inflation target?)

So there we are. A low unemployment rate. No more deflation risk, or even failure to hit an inflation target. Nominal GDP growth would be higher, pleasing Scott Sumner. The fed funds rate would rise to maybe 6%, maybe higher. Goodbye to ZIRP. No NIRP for you! Goodbye to liquidity trap.

And the solution to our secular stagnation was sitting here all the time. What a great idea. Fiscal stimulus shifts the IS curve to the right. Why didn’t I think of it? why way out of difficulties were right there looking at us all the time. Why didn’t Krugman or Stiglitz or Summers think of it, or Romer when she was CEA chief. Why didn’t Obama propose this in 2009? Oh, wait!

Fiscal policy is so wonderful a form of stimulus. Makes me wonder why we had a large tax hike in 2013, and a budget sequester, and 16% decline in real federal defense purchases in the past 5 years, and a 5% drop in real federal nondefense purchases in the past 5 years. Because Democrats believe in fiscal stimulus! Bernie believes in fiscal stimulus, which is why he spoke for 8 hours on the Senate floor protesting that the tax hikes in 2013 were too small.

24 whatever February 26, 2016 at 12:55 pm

How is a tax hike fiscal stimulus?

25 Boonton February 26, 2016 at 2:04 pm

A tax hike that is matched by an equal spending increase would be fiscal stimulus via the ‘balanced budget multiplier’. Basically you are taking a dollar that would only be partially spent from a taxpayer and giving it to the gov’t that would spend the entire dollar. A tax hike whose purpose is only to reduce the deficit would not be fiscal stimulus.

There’s a managing expectations game here. In reality even if Sanders won with a slight Democratic majority in Congress he would not get a stimulus program premised on 10%+ possible GDP slack. Note that the Obama stimulus was cut down despite facing a collapsing economy and a huge electoral mandate. A stimulus program that actually gets passed might be premised on only 2-4% GDP slack.

26 Robert Bostick February 29, 2016 at 4:35 pm

Federal Taxes don’t pay for anything. All the Administration had to do was request a larger stimulus package in ’09. Romer recommended $1.5 Trillion and Summers said no because he didn’t want to make the case before the House.

27 Hopaulius February 26, 2016 at 9:11 pm

Justin Wolfers in the NY Times reports about this that the fatal error is that Friedman assumes a multiplier of .89 will continue even after the stimulus ends. My non-economist’s question: how is a multiplier of .89 a net increase for the economy? The government takes $100 and turns it into $89 of output. Since the $100 is taken from the future via deficit spending, isn’t there interest paid on that $100? So eventually the $100 plus interest has to be paid back from the $89 of “increased” output. It’s hard for a non-magician like myself to see how the long term effect of the multiplier is anything but net shrinkage.

28 Hopaulius February 26, 2016 at 9:12 pm
29 Boonton February 27, 2016 at 1:25 pm

Good question, let me take a shot at answering it.

First, very basic the multiplier comes in the form of increasing demand. Demand is actual purchases. If I have $1000 in my matress and gov’t taxes me $100, I now have $900. I’m less well off as a result by this is not a direct part of the real economy (meaning GDP). It can be if this loss causes me to change my behavior, if I spend less money in order to replenish my lost savings. But by itself it doesn’t have a real impact. Consider suppose you snuck into my bedroom, took the $100 and put it under your mattress. Then you forgot you did that and I rarely check on my nest egg in my bedroom. What changes out there in the ‘real economy’? Nothing, everyone still goes to work, buys stuff at stores and so on.

So the multiplier comes from the fact that if someone earns some income, they will spend some of that earning and save the rest. The gov’t pays $100 to me for snow plowing. I put $20 in my mattress and blow tipping a stripper at a club. The stripper takes the $80 she got and gets her car detailed for $60 while saving $20 in her mattress. Keep going with this and at some point you’re left with a penny that ends up in the last mattress rather than being spent.

So first, the multiplier happens over a period of time. The longer you wait the higher the multiplier will be. So you could very well have a multiplier that appears below 1 when you’re measuring a quarter or a year but end up being 1.2 or 2 if you’re going out two years.

Second, a multiplier of less than 1 simply implies that spending $1 adds less than $1 to GDP. It would still add, however. Consider http://marginalrevolution.com/marginalrevolution/2010/08/me-defending-fiscal-policy-or-confusions-about-the-multiplier.html. In his example, a road project costs $1 but because it crowds out some private projects there’s a slight negative of $0.30. Because of “some positive second-order effects” (i.e. the fact that people will spend some of the additional income earned from doing the road project) he assumes those add back $0.30 to make the multiplier exactly $1. But even if it was only $0.20 coming back that doesn’t mean GDP goes down, it would still go up by $0.80.

The interest on debt or taxes to pay for the stimulus are factors to consider but only once you achieve a full employment economy. If your neighbor told you his credit card debt was crushing him, you might feel sympathy but if he also said he was only working 20 hours a week because he likes watching TV shows…your first comment might be why not work 40 hours and double your income then maybe your debt would feel easier to get under control. If an economy is fully employed the multiplier will drop to 0 or even negative because gov’t cannot increase its spending without decreasing someone else’s. In a partially employed economy gov’t can increase spending by tapping unemployed resources leaving everyone else’s spending untouched.

Of course once you are at a fully employed economy, you may not be happy. You may have an economy with all types of supply-side problems (i.e. regulations, poor economic policies, invasive laws, aging population, exhausted natural resources etc.). Even though all your resources are fully employed the output is not sufficient to give everyone a good standard of living or positive economic growth. At that point the multiplier ceases to be very helpful.

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