Major Economic Oops!

Paul Krugman, Laureate of the Sveriges Riksban...

Paul Krugman, Laureate of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2008 at a press conference at the Royal Swedish Academy of Sciences in Stockholm (Photo credit: Wikipedia)

Who was right and who was wrong about the Great Recession and how to deal with it, Republicans or Democrats?  Henry Blodget has an opinion on that, an opinion buttressed with facts. Blodget is a former senior equity research analyst for CIBC Oppenheimer and head of “the global Internet research team at Merrill Lynch. He now co-hosts the “Daily-Ticker” broadcast at Yahoo Finance and has published a cogent online article on the subject. There’s really no good way to summarize it, but it’s not long and for ease of reading I will give you the first part of it here.  (Link to the whole article comes later.)

For the past five years, a fierce war of words and policies has been fought in America and other economically challenged countries around the world.
On one side were economists and politicians who wanted to increase government spending to offset weakness in the private sector. This “stimulus” spending, economists like Paul Krugman argued, would help reduce unemployment and prop up economic growth until the private sector healed itself and began to spend again.

On the other side were economists and politicians who wanted to cut spending to reduce deficits and “restore confidence.” Government stimulus, these folks argued, would only increase debt loads, which were already alarmingly high. If governments did not cut spending, countries would soon cross a deadly debt-to-GDP threshold, after which growth would be permanently impaired. The countries would also be beset by hyper-inflation, as bond investors suddenly freaked out and demanded higher interest rates. Once government spending was cut, this theory went, deficits would shrink and “confidence” would return.

This debate has not just been academic.

Those in favor of economic stimulus won a brief victory in the depths of the financial crisis, with countries like the U.S. implementing stimulus packages. But the so-called “Austerians” fought back. And in the past several years, government policies in Europe and the U.S. have been shaped by the belief that governments had to cut spending or risk collapsing under the weight of staggering debts.

Over the course of this debate, evidence has gradually piled up that the “Austerians” were wrong. Japan, for example, has continued to increase its debt-to-GDP ratio well beyond the supposed collapse threshold, and its interest rates have remained stubbornly low. More notably, in Europe, countries that embraced (or were forced to adopt) austerity, like the U.K. and Greece, have endured multiple recessions (and, in the case of Greece, a depression). Moreover, because smaller economies produced less tax revenue, the countries’ deficits also remained strikingly high.

So the empirical evidence increasingly favored the Nobel-prize winning Paul Krugman and the other economists and politicians arguing that governments could continue to spend aggressively until economic health was restored.

And then, last week, a startling discovery obliterated one of the key premises upon which the whole austerity movement was based.

An academic paper that found that a ratio of 90%-debt-to-GDP was a threshold above which countries experienced slow or no economic growth was found to contain an arithmetic calculation error.

Once the error was corrected, the “90% debt-to-GDP threshold” instantly disappeared. Higher government debt levels still correlated with slower economic growth, but the relationship was not nearly as pronounced. And there was no dangerous point-of-no-return that countries had to avoid exceeding at all costs.

The discovery of this simple math error eliminated one of the key “facts” upon which the austerity movement was based.

It also, in my opinion, settled the “stimulus vs. austerity” argument once and for all.

The argument is over. Paul Krugman has won. The only question now is whether the folks who have been arguing that we have no choice but to cut government spending while the economy is still weak will be big enough to admit that.

The discovery of the calculation error, after all, came only a few months after the United States voluntarily cut spending through a government “sequester.” This sequester is hurting the U.S. economy, and it is also depriving American citizens of some basic services–like a fully staffed air-traffic control system–that most first-world countries regard as a given in a developed economy. And with America’s government deficit already shrinking (thanks to the rollback of some tax cuts and a modest increase in taxes), it is now even clearer that the sequester did not have to be adopted.

There is more to the article wherein Blodgett urges cooperation between the two political parties, evidently finally giving in to an unrealistic fit of rationality. Please follow this link if you’re up for a dose of that. Also, this information dovetails with an NPR pod-cast I heard recently giving more details of just how the error in the economics study was discovered. A grad student who was doing a paper found it. It would be humorous if it weren’t so tragic.

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About Jim Wheeler

U. S. Naval Academy, BS, Engineering, 1959; Naval line officer and submariner, 1959 -1981, Commander, USN; The George Washington U., MSA, Management Eng.; Aerospace Engineer, 1981-1999; Resident Gadfly, 1999 - present. Political affiliation: Independent, tending progressive as the GOP recedes from its Eisenhower roots.
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15 Responses to Major Economic Oops!

  1. jwhester says:

    Any bets on whether those preaching austerity will be “be big enough to admit” their mistake? It was really a bit of a ruse that there was ever much controversy among economists. Keynesian principles have been accepted for generations, but they came under attack once big money decided that they could lower their tax bill by pushing the narrative that the big problem is government spending.

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  2. Jeff says:

    Great Article!

    Like

  3. PiedType says:

    I’ve read about the newly discovered problems with that paper. Worse than the paper itself, I think, is that any single paper or study could have been so influential. What ever happened to consensus among many experts?

    Will the “Austerians” be “big enough to admit” they were wrong? Will we now see “cooperation between the two political parties”? We can only dream.

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    • Jim Wheeler says:

      @ PT,

      What ever happened to consensus among many experts?

      On a different NPR pod-cast I heard an expert opine that errors are very common in economics papers, so much so that it’s unusual not to find them. I’ve concluded that the subject is suspiciously malleable because at its heart is human nature and politics. For example, the principle of supply and demand is valid as far as it goes but when you overlay different forms of government and the complications of politics, even the effects of even that become less predictable. Another example, from a different Planet Money pod-cast, is the sugar industry. A huge candy factory moved from the United States to Mexico. Why? It wasn’t because of taxes, nor OSHA requirements, nor the availability of good workers, nor transportation, nor even necessary wage scales. It was because Congress, under influence of one of the most powerful lobbies in the country, had written into the Farm Bill a solid minimum price for sugar – it can not, by law, be purchased for less than $0.29 a pound. With that provision the candy company, which produced monstrous amounts of suckers, candy canes and the like, could not compete with foreign competition. But the beet farmers of Colorado and elsewhere are absolutely delighted with the legal provision. One big-scale beet farmer was quoted as saying, “Harvest time smells like money!” No wonder they call economics the dismal science. Dismal it is, science it ain’t.

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  4. ansonburlingame says:

    Having been one that views onnerous debt as a disaster waiting to happen, I offer some thoughts. I had already heard of the “math error” which was actually more than an error on an Excel Spread sheet found by students. Whole nations had been left out of the evaluation by the “learned economists” doing the study, like Canada for example. So go ahead and trash the study for sure.

    To attempt to put a single number on such a complex issue is not wise in my view. Obviously 90% is wrong as a threshold of disaster, if you will. But what about 100%, 125%, and on up? IS there some single number beyond which the whole house of cards of modern finance will crumble? I have no idea and neither does anyone else, in my view.

    At what point, or more likely a range of points, does real disaster become very likely, possible, or even a maybe. My guess is varous countries and empires have in fact found those numbers or ranges of numbers and gone down in history as failing, economically, militarily, etc. Just because one study failed to “find the exact number” does not disprove the idea and in my view we better keep looking, hard. I also seriously doubt that one number could apply to every country in the world, and in history for that matter.

    The grave error in government spending is not the total amount. It is how wisely that money is used to really stimulate, sustainably, an economy. Democrats over the last 50 plus years have always “thrown money” at many issues, unwisely, in my view. The proof of that assertion is that the problems at which the money has been thrown simply continue to flourish, on and on with never ending demands for yet more money. To some degree defense spending falls into the same category, never ending demand for more and more. I would point out in terms of defense spending however that a lot of that money has been wisely spent in the past. Just look at the dominance of our defense technology around the world today. No one can beat it, for sure.

    FOR SURE, to this observer, demanding more money for short term stimulus MUST BE accompanied by a very clear explanation of WHEN such amounts will no longer be needed. In other words how do we prevent stimulus from becoming “business as usual” after the economy settles out? That is the failure, in my view, of the 2009 stimulus package passed only with Dem votes. We spent a $ Trillion of so and then the bottom fell out of such stimulation. Dems demanded more and others said either NO or how much longer will you need it, with no answers provided. Just “trust us” was the implication.

    Anyone that looks today knows full well that our national debt will be about $26 Trillion plus in about now 8 years but no one knows what our GDP might be then. Go analyze that if you can.

    As well we all know that if Dems get their way Medicare (like) for all will be our “normal” in the coming years, but NO ONE knows our total debt or GDP IF that comes to pass. Again it is a trust us.

    We have been “trusting” the likes of Keynesian economics, designed to get us out of a depression long ago, to keep on keeping on a booming economy and “trust us” or “our people NEED the money” has been the assurances received. Thus over 50 plus years our economic growth has gone up 1/3rd LESS than our debt (300% compared to about 1000%) over a 50 year period. How long (oh Lord) can we keep doing THAT, I wonder.

    Anson

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    • Jeff says:

      I agree with parts of what you wrote. For example,

      “But what about 100%, 125%, and on up? IS there some single number beyond which the whole house of cards of modern finance will crumble? I have no idea and neither does anyone else, in my view.”

      However other parts are off the mark in my opinion.

      “Democrats over the last 50 plus years have always “thrown money” at many issues, unwisely, in my view. The proof of that assertion is that the problems at which the money has been thrown simply continue to flourish, on and on with never ending demands for yet more money. ”

      The story of the last 50 years has not been one of Democrats throwing money at spending so much as Republicans throwing money at tax breaks for rich people. The results have been abysmal, as you would expect when you realize we are right of center.

      In fact, every Democrat since WWII except Jimmy Carter has decreased the deficit as a percentage of spending and every Republican has increased the deficit as a percentage of spending. In fact, without the budgetary changes brought on by Reagan and Bush 1, Clinton’s actions would have completely paid our debt down to zero even ignoring the growth slowdowns caused by those two.

      “As well we all know that if Dems get their way Medicare (like) for all will be our “normal” in the coming years, but NO ONE knows our total debt or GDP IF that comes to pass. Again it is a trust us.”

      This also does not ring true. There is a simple way to check what will happen here and it involves looking at other countries with socialized medicine. Since we are the only first world country without socialized medicine and since we have double the health care costs of the alternative countries, there is really no guesswork here. Our costs would go down dramatically if we took simple steps like giving medicare greater latitude to negotiate and removed profit incentives for private inefficiency.

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      • Jim Wheeler says:

        @ Jeff & Anson,

        For what it’s worth, the economists on the NPR program were in agreement that there is no sharp breaking point in the debt to GDP ratio at which the “whole house of cards of modern finance will crumble”. It is a smooth curve.

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  5. I know I’m a bit of a cynic, but I’ve long suspected that the republicans who push austerity know that it is harmful, they know that a government jobs program would boost the economy by giving spending power to out-of-work families, and they know that Obama would then get credit for building a stronger economy. Anything to see Obama go down in the history books as a failure. Yes, I know that’s cynical, but maybe there’s some truth in it.

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  6. ansonburlingame says:

    Helen,

    Cynicizm cuts both ways. I can suspect that Dem policies related to entitlement spending is an attempt to buy the votes of the people getting that money. You as a liberal will claim foul over such an accusation but then turn around and blame all “excess” defense spending on the military-industrial complex dominated by fat cats that are rich.

    But both of us should look at the “grass roots” of some of the arguments. Consider Acorn, a black dominanted constituency demanding more for their needs from government. I have no idea who exactly was behind Acorn, but suspect that grass roots group of people were, well black and relatively poor.

    Then look at pictures of early Tea Party rallies, like the one right here in Joplin several years ago. THAT constituency was generally white and for sure “not wealthy” people demanding LESS from government. I attended that rally and saw zero “Koch Bros” involvement therein, for sure. Just a bunch of angry white people that wanted government to get off their backs in all sorts of ways.

    Anson

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    • Jim Wheeler says:

      And speaking of cynicism, Anson, and just for the information of Helen and other readers, the amount of state and federal largesse that has flooded into Joplin since the EF-5 tornado two years ago is now, if I’m not mistaken, approaching one billion dollars. That’s one-thousand millions! And the “generally white, not-wealthy, angry people who wanted government to get off their backs” have yet to turn down a nickel of it.

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  7. ansonburlingame says:

    Of course not Jim. Disaster relief cuts across all economic boundaries. The last publicly released figure that I have seen was some $2.5 Billion for PRIVATE, meaning insurance, proceeds and about $250 Million in government relief. You must have new sources for the $1 Billion in FEDERAL relief and I would be interested in that information.

    But again $1 Billion to Joplin for the tornado does not surprise me. Sure is a lot less than the $66 Billion for Sandy relief in the NE as well as authorized by Congress.

    The argument related to any disaster relief is when the money so used is BORROWED money rather than reallocation of existing funds that go to things like “Solyndra” and other waste, fraud, and abuse. But that is a whole different argument, unrelated to your concerns about not enough money of the “poor”.

    Just look at airline delays. The money was ultimately found to keep controllers controlling but without just borrowing or printing more money to do so. Congress woke up and told FAA to priotize the needed cuts from sequestration and keep controllers, controlling.

    Anson

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    • Jim Wheeler says:

      The one-billion dollar figure came out of my head just from reading articles in the Globe and is admittedly squishy, but I’ve tried to track some kind of running rough total just because the money just keeps flowing in. And by the way, that includes state as well as federal – the state aid has been substantial. I tried googling for the number and can’t find it – the politics wouldn’t encourage the compilation of such a total, I think. Interestingly, there is now a Wikipedia web page on the 2011 Joplin Tornado and it mentions that,

      . . . the cost to rebuild Joplin could reach $3 billion.

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  8. ansonburlingame says:

    Deservedly so, I get quickly “corrected” if I pull numbers out of the air. Even the $3 Billion, now in Wikipedia, is an “old number”. It was the early estimate, as I recall of what it would cost to “rebuild” based on first estimates. And of course the reported information of $2.5 Bill PRIVATE plus $250 Million from government falls within that range. I believe it is important for all to recognize that about 80% of all “rebuilding” will routinely come from “private sources”, be it Katrina, Sandy, Joplin or whatever. Government money gets all the attention but it is “only” a small portion of what it takes to ever rebuild after a disaster, historically.

    To “politically” add up the government numbers will be controversial if such is ever attempted. Joplin receives many different “grants” for government sources all the time. Putting all those grant monies into the rebuild category would be wrong, in my view. So just adding up ALL the government funds coming to Joplin since May 2011 would be a misguided attempt to evaluate all the strictly “rebuilding” efforts.

    But so what. My point is all of that money, rebuilding or not, should be budgeted money and limited to available revenues based on what the tax base provides to government, not borrowed money, which someday will “kill us” at least our kids and grand kids.

    AB

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    • Jim Wheeler says:

      You said,

      My point is all of that money, rebuilding or not, should be budgeted money and limited to available revenues based on what the tax base provides to government, not borrowed money, which someday will “kill us” at least our kids and grand kids.

      I agree with budgeting, but I disagree that rebuilding funds shouldn’t be tallied. In fact, I don’t see how you can budget without doing so, so I find your response confusing at best. And, saying 80% of all rebuilding comes from private sources sounds nonsensical – what is the evidence for that? Grant money always comes with clear labels, as does money appropriated for disaster aid – no reason for confusion there that I can see.

      I see four distinct categories that would serve the public interest if they were tallied and I’m frankly surprised that you as a Conservative would resist doing so, the four categories being:

      1. State aid appropriated specifically for the purpose.
      2. Federal aid appropriated specifically for the purpose.
      3. Insurance proceeds (mainly for the record and so the public can budget aid properly and not duplicate insurance).
      4. Charitable aid.

      However, this would be a contentious job of investigative journalism and there would be political resistance. I’m not holding my breath.

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