My debate with Noah Smith on fiscal policy

This is at Bloomberg, I think this is the most interesting paragraph:

But Noah, I have a question for you. You’ve written several columns about how the American economy is becoming more monopolistic. If true (and it is not exactly my view), that implies output could be much higher with current resources, even at full employment. A boost in demand could spur firms to produce more, rather than restricting output so much. So are you now a fan of these Trumpian deficits? They may not be your preferred form of deficit spending, but do you see them still as a net positive?

But of course there is much more at the link.


Why ask a question like that, and then not ask for a response when he completely ignores the question?

There was a good deal "no, no, let me ask you a question," in this brief exchange, but here is Noah's response:

"As you say, monopoly power could potentially increase the case for stimulus in bad times. But if you believe government debt can get too large -- as most people probably still believe -- you should reduce deficits, or even pay down some debt, during economic good times."

And it looks like Noah's answer was... "NS: I don’t think running government deficits is the proper way to deal with monopoly power -- for that, we should use stronger antitrust legislation." Which seems .... pretty sensible!

The question was "So are you now a fan of these Trumpian deficits? They may not be your preferred form of deficit spending, but do you see them still as a net positive?" He did not answer that question, at best he quibbled with the premise. The closest he came to answering the actual question was "Raising productivity is certainly a priority. Some Keynesians do believe that stimulus spending can raise productivity, even during a boom. For all our sakes, let’s hope they’re right." That seems a lot like fence sitting to me.

True, Noah didn't really spell it out, but his point is pretty obvious with a bit of charity -- i.e., yes, maybe the Trump tax cuts may help with monopolies, but it's unclear whether that's the case, and spending far from being the best tool for the job, so no, it's no the tax cuts are not a net benefit when all relevant measures are taken into account (fighting monopolies, preparing for the next recession, etc.).

I'll put it this way... it's like Tyler is saying, "Well, taking a bunch of Adderall helps you get your work done faster, so taking it is a net benefit, right? Sure, maybe you'd PREFER to learn reasonable time-management techniques and tricks of the trade to be more productive in a sane fashion, but in the meantime, you should take a bunch of Adderall to get work done super fast, right?"

Trump and GOP tax cuts promote greater monopoly and greater rent seeking. They are the opposite of a Keynes prescription for tax policy because they make building capital assets more costly.

If the maximum investment in capital is made, capital depreciation equal investment in capital so even a 100% tax on business profits (which are zero) does not reduce investment.

Lower taxes on profits promotes cutting capital investment to create capital scarcity, thus pricing power by reduced production creating scarcity. Any profit is used to buy competitors and then to cut investment by the combined business.

As business tax rates have been cut over the past half century, tax "dodges" like expensing investment, which only brings future cost by depreciation into the year of investment, have been replaced with calls for tax credits, ie, the IRS pays 20% or more of investment cost. Otherwise, with low tax rates on profits, better to create a monopoly and cut supply to allow prices to far exceed costs.

This is Noah Smith of "Fed is awesome; see no bubbles" fame.

We're still looking for any evidence that QE did anything bad but I suppose sooner or later the sun will swallow the planet and that will then prove it.

US$230 Trillion in global debt ain't enough for 'ya?

Get your affairs in order.

"As economist Robert Lucas put it at the time, “Everyone is a Keynesian in a foxhole.”"

Interesting line.

yeah, Keynesianism sure dominates academics and government -- but there are many varieties of it.

The original economics of John Maynard Keynes is now nearly defunct as theory, but not in practice. Keynes’s 1936 "General Theory" portrayed the free market as fundamentally unstable and touted enlightened government intervention as the stabilizer. The stability that allegedly lay beyond the market’s reach was to be supplied by the federal government’s macroeconomic policymakers — the president (with guidance from his Council of Economic Advisers), the Congress, and the Federal Reserve.

All varieties of Keynesians agree on the (supposed) critical function of government in guiding the economy, although rare is any Keynesian who openly admits to being a socialist.

Effective government economic central-planning ("Fiscal Policy") is impossible to do -- the complex dynamic movements of economic variables move in unknowable directions & degrees. But even self-proclaimed "fiscal conservatives" & semi-libertarians here think it's absolutely required in U.S.

I think JWatts was referring to the supernatural aspect of the original line, "no atheists in a foxhole."

What is the natural mechanism of free markets to maximize investment to the point no economic profit exists because capital increases production to zero scarcity and prices equal costs including capital depreciation totally offsetting investment?

And vast regions exist with no taxes or regulation on business and capital, ie, effectively no government, yet these resource rich regions produce less than big government resource scarce small patches like NYC, Boston, Chicago, SF. Eg, Afghanistan, Somalia, etc.

Or the Americas before 1496. The invasion of the Americas was driven by government. Ironically the Mayflower Compact as "capitalism" is actually socialism because the workers hired by the capitalists stole the property of the capitalists, claiming the workers should get the fruits of the labor that was made possible by the capitalists transporting and provisioning the workers creating a colony chartered by government. However, the capitalists had a monopoly on the supply chain and took back their stolen earnings in rents the rebel workers had to pay.

The biggest economies have always been in the nations with the biggest governments driving the economy.

Meaning, as I understood him, that in desperate times it's understandable that one might begin to believe in magic.

Or in empirical economic evidence accumulated over decades.

Bernanke was a scholar of the Depression. If he believed in evidence he wouldn't have gone all Keynesian like he did. He panicked.

Few thoughts:

1. Stimulus and deficits....are they the same thing? Remember the old balanced budget multiplier says you can raise taxes by $100B and spending by $100B and that will increase GDP by $100B. Even that works as stimulus because you are essentially taking money from the private sector, which doesn't want to spend 100% of it, and spending it via the gov't sector.

2. Spending.....spending is gov't purchase of goods and services. Transfer payments are not the same thing because lower tax bills or additional money in social security checks may or may not be spent by those receiving them.

3. I'm starting to suspect deficits don't actually matter and it might be better to just better to run the gov't on 100% deficit financing.

On #3 I've often thought the same thing. Even if you had to start monetizing all that debt -- slowly, of course -- wouldn't that just result in inflation that would essentially act like a flat tax on all dollar holders?

I guess the downside would be a potential nominal shock of the resulting inflation, but I don't know if it would restrict growth just to the degree of the implied taxation or if there would be additional restraints on growth beyond the implied taxation. I wonder if there is any serious literature on this approach?

Keep in mind if we went to 0 taxation the following might offset inflation:

1. Decrease gov't spending, zero tax boosts incomes which lower many entitlement programs.

2. Increased savings, ultimately you are either going to save some of your new higher paycheck or spend it. Ultimately it's going to end up in a bank somewhere which means more bond purchases.

3. Deadweight tax losses are gone, no matter how well designed the tax there are lots of costs imposed beyond the tax itself. A 100% deficit 0% tax economy has more capacity than one with taxes.

"Decrease gov’t spending, zero tax boosts incomes which lower many entitlement programs."

Very few entitlements go to those who are paying any taxes, so zeroing taxes would increase the money they have to pay workers by zero.

The Warren Buffetts paying millions in taxes and then getting $35,000 in SS plus $10,000 in Medicare entitlements are few. 80% getting entitlements pay no taxes on income to the Federal government, paying only gasoline, electric, telephone, etc taxes.

@Boonton - "1. Stimulus and deficits….are they the same thing? Remember the old balanced budget multiplier says you can raise taxes by $100B and spending by $100B and that will increase GDP by $100B." - what textbook is this? Must be very old. Is the assumption that taxes will not be paid in about a year while spending will take place immediately?

This is kind of off topic but can somebody explain why the Fed doesn't just let the balance sheet run off? If QE left the Fed with a couple trillion in bonds, why not just collect the coupons? Why sell back into the market when the Treasury already has a big supply to try to sell?

The Treasury and the Fed are the same entity, economically speaking, although obviously they are separate in an accounting and legal sense. In particular, the Fed returns any profits to the Treasury.

So if the Fed buys bonds from the Treasury in exchange for cash, holds the bonds to maturity, receives the coupons and principal in cash from the Treasury, and then returns that cash to the Treasury, the net effect is just that the Treasury has more cash in return for nothing. This is also known as monetizing the debt, it is inflationary, and generally considered a poor idea.

In contrast, selling the bonds back into the market would reduce the money supply by an amount equal to the initial increase. Since the Fed is looking to increase and then decrease the money supply in order to smooth out the business cycle, this is more desirable, assuming they manage the timing adequately.

Thanks. But isn't it too late for that? QE is already profitable. Now we're just arguing about how inflationary it will be. Considering that the Fed is running a negative real interest rate policy, it's already running an inflationary policy. The issue now is just how much.

It's depressing. The GOP blowing up deficits looks like a "Nixon to China" thing. The only Democratic solution to deficits is to increase taxes. I mean, sometimes yeah, but...

The bipartisan consensus in favor of the Permanent Humungous War Machine is the most depressing part.

The only realistic end game I see is some kind of devaluation/inflation. The sooner the better.

By the way, the phenomenon of a deficit increasing by hundreds of billions of dollars well into an economic recovery has been happening since 2015, but nobody cared until Trump and the GOP poured some gasoline on an already-raging fire, so spare me your suddenly-furrowed brow Noah.

If one believes that we will hit that devaluation roadblock at some point, surely the magnitude of the deficit matters. It was bad into the recovery, though it decreased each year 2012-2015. I agree there is no political restraint in sight.

The deficit returned to less than 5% GDP around 2013. Being around 5% of GDP appears to be the normal since 1980 or even before.

The relevant statistic is... Not being critical just wondering.

Deficit % GDP - NGDP growth rate? I guess?

If NGDP is 10% and the deficit is 10%....I would hypothesize that it is sustainable Indefinitely.

If NGDP is lower than deficit % GDP....

Paging Scott Sumner.

NGDP = RGDP + inflation.

There are 6,000 hate crimes on average according to the FBI. States don't really monitor hate crimes for sexual discrimination or at least Ohio doesn't. There are on average 14,000 murders on average, and while hate crimes stayed constant, there was a surge in 2015 of murders...almost 16,000.

Hate crimes legislation in Ohio only affects the penalty phase, not the resources given to law enforcement. The assumption then is that the 8,000 or so, probably a lot less, hate crime murders deserve more resources, when the motive is usually a lot more clear, and random, unless there are organized hate crime groups that I'm unaware of.

"t’s depressing. The GOP blowing up deficits looks like a “Nixon to China” thing."

If by China, you mean a future with rampant inflation and a heavily devalued dollar for a decade or two, to resolve the debt. Then yes.

@BD - "The GOP blowing up deficits looks like a “Nixon to China” thing" - but your analogy is inapt. The Nixon to China thing worked out brilliantly, and Nixon on par, given today's standards, and even including Watergate spying, was a great president, while it's not clear at all that the GOP blowing up deficits will look good a generation from now, assuming it lasts.

If every sector is monopolized (and assuming the demand elasticity is the same) then the inefficiencies cancel each other and so resource allocation and output is the same as in perfect competition. That is what happens in Romer's growth model at least.

Also, who said deficit spending can increase output? I never heard of that.

Also, who said deficit spending can increase output? I never heard of that.

Deficit spending increases demand. Unless the economy is at capacity, that is how you get more output.

I think we need a giant asterisk on this.

An increase in the deficit (it is the derivative that matters here) will “increase demand” if and only if the central bank is not targeting inflation. So no, I disagree.

A tax cut may increase GDP in the short term for supply side reasons. The deficit part of it is irrelevant.

OK yea, and putting water on a fire will put it out *unless* someone else is also matching the water you put with gasoline. If we don't hold all else equal...

There is no clear link between fiscal deficits and aggregate demand. An increase in fiscal deficits imply in a greater demand for credit which induces into higher savings and hence a reduction in private demand. In standard infinitely lived agents economic models we have ricardian equivalence so that fiscal deficits will not impact economic activity. In models with overlapping generations (where agents don't live forever so only future generations pay taxes so savings don't increase in the present) a fiscal deficit will just lead to higher interest rates and hence lower private investment and hence LOWER output without affecting aggregate demand.

Also, there is no clear link between aggregate demand (which is the same as the aggregate supply of money) and output. An increase of aggregate demand might lower output by causing inflation reducing the returns on holding cash deposits which reduces the equilibrium amount of cash people hold, reducing economic efficiency and hence output.

Overall, this "keynesian" understanding of economics to me appears to be the same as the understanding of physics that heavier objects fall faster: that is, the ignorance of the layman. However, since economics lacks effective barriers for entry there is a lot of ignorants in economics publishing papers.

This was ok, not great.

I particularly disliked that Tyler forgot what he knew about counter-cyclical fiscal policy, to make a debate, and let Noah have that position.

Tyler pretended that half a counter-cyclical policy was just "Democrats spending." And that pro-cyclical spending is just "Republicans spending too."

I think there is a difference in kind to be defended, if you ever want to see deficit reduction during expansion ever again.

This was also interesting:

"TC: I have a proposed rule for fiscal policy: Invest in good projects and good projects only, based on a cost-benefit test. That sounds trivial, but in reality hardly anyone follows it or even agrees.

I do understand that Keynesian macroeconomic theory suggests that in a downturn we should lower our standards for project evaluation, so as to boost aggregate demand with more spending. I’m not persuaded."

I guess I am "lower our standards" guy, but not too much. Meaning that there is overlap here in our beliefs.

The chart does not support counter cyclical policy as Noah suggests. Look at deficits over time since the Nixon shock. From 1980 on, we see large increases in deficits always precede recession. Noah's meta study is bogus, it has few example from the US except for road building in the 1960s. We went through that met analysis, is was specifically designed to fool us in the US. The IMF at the time was conning the uneducated American economists,

The deficit chart, and its relationship to blue bars tell us something in the US counter cyclical theory is unproven, at best, pro cyclical is more likely.

Counter-cyclical spending is a goal, not anything discovered in nature.


No such pattern is present in the data.

" A boost in demand could spur firms to produce more, rather than restricting output so much"

Who is restricting output? And how is a big tax cut for the rich and the corporate going to boost demand?

More yachts???????????

I know you are doing your best to find arguments to support the Trump deficit increases, but please, please, please, come up with arguments that won't embarrass freshman economic students.

Monopoly theory says that monopolists gain greater profits when they can restrict production and keep prices high (in essence only selling to high willingness to pay customers where their margins are greatest). Lower production than capacity is one of the signatures of monopoly power.

So giving more money to the monopolists will reduce the power of those monopolists?

Who are you kidding other than yourself?

"And how is a big tax cut for the rich and the corporate going to boost demand?"

You ask that, despite the numerous corporations that have already said they're expanding capacity, bringing cash hoards back into the US and even giving bonuses to their employees?

Jeez, get a new talking point. That one is deader than Jimmy Hoffa.

The latest estimate for how much money Donald Trump will save due to the last tax cut is about $15 million/year. Rich guys like Trump do not increase their expenditures because they already have more than they need.

So their tax cuts do not increase demand.

How much of a reduction in your taxes will there be? Will it be more than the $1.50/week that some secretary will get that Paul Ryan bragged about?

And here's a history lesson for you. George W. Bush reduced taxes. Remember what happened next?

The crash of 2008.

I think prices and wages freeze would help to break the back of inflation.

Economists ought to ask themselves why should fiscal policy boost demand (by a large amount).
When not financed by printing money, the deficit will mostly redirect money someone would have spent otherwise. It is only through reducing the demand for money (through higher interest rates) that fiscal policy will have an effect in a closed economy. Why should we expect this effect to be large? Why bother when monetary policy can be used as a much cheaper and effective cure?

For all the research into the monetary transmission mechanism, Economists never stopped to explicitly describe the fiscal transmission mechanism.

The US just converging back to Latin America. Like Argentina: Argentina was much richer than the rest of LA but after several decades of stupid macro politicies they managed to get very close to LA's average per capita GDP. The US is also converging back: from 2005 to 2017 the US's cap GDP growth has been similar to Argentinian GDP growth from 1929 to 1990, when they converged to LA standards of cap GDP. Running deficits of 1 trillion dollars every year will eventually reduce the credibility of the US's government which will eventually lose credibility, this will eventually affect the financial system which will finally "argentinianize" the US.

Take a loan, buy in bulk, sell for premium!
Profit $$$

Noah won the debate, Tyler had an original thought about output being less than it could be due to monopoly, ergo, there are slack resources that increased government spending can utilize. It was a good layperson debate. A few academic cites would have been important for the reader, but small quibble and maybe the Bloomberg editor does not want to make it look too nerdy.

I think the growing concentration of industries is a bad thing. I also think that monopolies have a hard time surviving without government protection. So the core issue is really about getting government out of the way and allowing a more competitive field.

Part of the growth of Amazon was its ability to avoid sales tax. But it also avoided local real estate taxes etc. Today it is seeking to grow into a second headquarters with generous subsidies. If only governments could be more even-handed in their treatment of companies perhaps we would see more growth. BTW it is amazing that Bezo has spent so much of his career avoiding local taxes but is a liberal.

Trump as President seems to be the same as Trump as a businessman. He is very comfortable with risk and that in part explains his past success. Can his tax reductions encourage greater growth in America? Yes. At the levels that Trump expects? Well, the little roulette ball lands on somebodies number every turn, but I still don't bet on the thing.

Can the Trump fiscal expenditures on infrastructure and defense stimulate the economy? On net, perhaps. But if history is any lesson the political process will make such projects unnecessarily expensive and bureaucratic and any potential benefits will be lost by the inefficiencies in the process. Money that could have gone to the private sector will be wastefully redistributed through the political rent-seeking of politicians and interest groups.

Trumps greatest weakness seems to be that he thinks he can generate greater efficiencies out of government expenditures and get a better return on the investment then historical patterns would indicate. President Trump may have a rude awakening combating the regulatory burdens, rent-seeking inefficiencies, and low-level corruption of government projects.

Claiming that stimulus spending increases GDP does not give me great comfort. A 1% growth in GDP in year one that suppresses growth in years 3-10 as you repay the debt doesn't seem like a great idea. Especially if the private sector is able to achieve 3% growth with those funds if they had access. Not to mention that reform of government could create greater efficiency and higher rates of return without increasing expenditures.

Deficits are a problem if you are taking money away from productive citizens to redistribute into inefficient politically favored enterprises. Deficits funded by foreign actors can be an issue because of the above reasons plus the interest payments going to foreign actors. (Of course, they will use those interest payments to buy American goods so the loses can be overstated.) Government spending is not an automatic negative. Deficits are not awful by their nature. The political process just drains the benefits out. Sort of like a physician using bloodletting to cure a sick patient.

BTW Perhaps someone can explain why a government can not demand greater efficiency and austerity doing a recession and government will not demand greater efficiency and austerity during a boom. Simply wasteful government programs and policies just stay in place once they are created come hell or high water.

Did Noah really link to that endlessly discredited study on fiscal multipliers again? Noah has been schooled on that again and again, here is Scott Sumner to clearly explain why that is nonsense;

If you have a Central Bank managing your monetary policy, which last time I checked the US has, then all fiscal policy does is pile up debt. The reason is simple, when fiscal policy starts working by raising inflation, the Fed raises interest rates to offset the inflation and negates the effect of fiscal policy. Japan proved this time after time. It is not debatable.

"As for boondoggles, it seems highly unlikely that repairing dilapidated roads and bridges, or plugging holes in state budgets, will be seen as white elephants." << Noah is right about this BUT why didn't Obama & Dems, like in Cal, do this?
CA has huge road problems, yet is doing boondoggle "fast train".
Solyndra was an Obama boondoggle.

The Wall will be a Trump half-boondoggle, yet will likely work (at some less than 100% but more than 50% efficiency).

The quality and economic value of the new projects, and their Returns on Investment, including both gov't and private sector investments, will be the bigger influence on macro results.

A huge problem with most macro, including macro studies of both monetary & fiscal stimulus, is the almost demonstrably false assumption that investment returns are equal and the differences in results are due to the gov't monetary or fiscal policy.

I claim that most business cycle & macro results are more dependent on total actual returns on investment, altho the fiscal & monetary policies are also influential.

Trump's policies are likely to have much higher ROIs than Obama's.

Noah doesn't like that.

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