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Absence of Evidence for the Pain Caucus Case - Grasping Reality with Both Hands

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Grasping Reality with Both Hands The Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, RealityBased, and Even-Handed Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.

Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch August 03, 2010

Absence of Evidence for the Pain Caucus Case We are once again live at the *Economist* by invitation: http://www.economist.com/economics/by-invitation/guestcontributions/there_absence_evidence_expansionary_case"> There is an absence of evidence for the expansionary case Brad DeLong our guest wrote on Aug 3rd 2010, 17:54 GMT LONG ago Martin Feldstein, Andrew Abel, Olivier Blanchard, Thomas Sargent, Charles Kindleberger, and Barry Eichengreen taught me that what we did—what made us economists doing analysis rather than ideologues hearing voices in the air or propagandists trying to please our political masters—was that we economists (i) generalised from historical patterns (ii) to build a family of self-consistent models that we then used (iii) to guide our analysis. But I cannot fit the arguments that short-term expansionary effects will follow from transitory contractionary fiscal policy in the core economic powers—the U. S., France, Germany, and Japan—into that framework, no matter how hard I try. Start with what I am now told that all economists believe: that contractionary monetary policy in the form of an open-market sale of government bonds for cash that raises interest rates will reduce production and employment in the short run. First, the government sells bonds for cash. Second, the greater supply of bonds on the market diminishes their prices—which means higher interest rates. Third, higher interest rates make it more costly for businesses to finance investment spending, and also reduces asset values so that households feel poorer and are less willing to spend on consumption goods and services. Fourth, the flow of spending then drops. Fifth,

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Absence of Evidence for the Pain Caucus Case - Grasping Reality with Both Hands

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general-equilibrium considerations then attenuate or amplify this drop. And, sixth, this drop in spending is what diminishes production and employment in the short run. The caveats are that perhaps the open-market operation won't raise interest rates—as in a liquidity trap, or if the open-market operation is taken as a credible signal of a change in long-run policy that diminishes risk and so makes investors more confident holding assets. Then there will be no rise in the coat of capital to businesses, no fall in household wealth, no change in either flow of spending, nothing for general equilibrium considerations to attenuate or amplify, and so no contractionary effect on production and employment. Bit these caveats are just that—caveats: if you want to argue that they apply, you have to make the case that the current situation is a special case. You can't just wave your hands and say that nobody knows. That, at least, is how I thought the game of economic analysis was played according to the rules. And that is the analysis of the short-term effects of contractionary monetary policy Now let's turn to fiscal policy. I am also now told that nobody knows whether a transitory cut in government purchases that finances a long-run reduction in taxes will be contractionary or not. I am now told that there are perfectly reasonable and competent economists on both sides. But when I rerun the steps of our argument, this time for fiscal policy, I don't see that. What I see is this: First, the government cuts back on government purchases. Second, the flow of spending then drops. Third, general-equilibrium considerations then attenuate or amplify this drop. And, fourth, this drop in spending is what diminishes production and employment in the short run. There are, once again, caveats. This time: 1. Perhaps the central bank responds by cutting interest rates substantially, which boosts spending by businesses and households and so offsets the fall in government purchases. 2. Perhaps without central bank intervention financial market reactions lead to a substantial fall in interest rates, which boosts spending by businesses and households and so offsets the fall in government purchases. 3. Perhaps there is no such thing as a transitory cut: perhaps all cuts in government purchases are and are expected to be permanent—in which case the fall in expected future taxes is an order of magnitude larger than the fall in current government purchases and it is possible that the resulting boost to private spending offsets the fall in government purchases. It happens that right now I believe that case (3) applies to Greece and perhaps Italy, and that case (2) applies to Portugal, Italy, and perhaps Spain. And I hope without much reason that case (1) applies to Britain. It happens that two years ago I believed that case (2) would by now apply to the core economies of the North Atlantic. But right now I see no evidence and no arguments that it does.

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Absence of Evidence for the Pain Caucus Case - Grasping Reality with Both Hands

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This absence of evidence matters. For these caveats are just that—caveats: if you want to argue that they apply, you have to make the case that the current situation fits into one of these special cases. You can't just wave your hands and say that nobody knows. Or, at least, that was how I thought the game of economic analysis was played according to the rules. Brad DeLong on August 03, 2010 at 12:17 PM | Permalink Favorite

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Comments Linkmeister said... Every stockbroker and bond salesman in history with product to move: "This time it's different!" Reply August 03, 2010 at 02:02 PM Bob Athay said... Thanks again, Brad. These "Live at the *" (* = unix wildcard character) posts provide a useful framework for those of us who haven't entirely given up on the possibility of finding reasoned arguments among all noise. I just wish that *someone* among the U. Chicago / Hoover institute crowd would make some reasoned arguments of their own. Either using the framework that you outlined or first making an argument as to why a modified framework is necessary. John Taylor will at least recognize that other viewpoints exist, but that's as far as he'll go. My engineering instincts tell me that they don't make a reasoned argument because they don't have one. Maybe David Stockman was right about Supply Side economics (and Republican policy in general) being nothing more than a Trojan Horse for policies that enrich the top 10% (mostly the top .1%, of course) at the expense of the bottom 90%. Reply August 03, 2010 at 02:53 PM tâtonnement said... "First, the government sells bonds for cash. Second, the greater supply of bonds on the market diminishes their prices—which means higher interest rates." I think it would strengthen your argument to phrase this as 'Second, the reduced supply of cash as a result of bond purchases leads to higher interest rates for those wishing to borrow...' A greater supply of bonds (falling prices, rising yields) is not a problem, it’s the fact that cash has been made more dear that causes problems for the cast of your Third point (businesses, households, etc.). This helps make your point in regards to a liquidity trap (no reason to swap zero yield bonds for cash, so supply is not contracted), as well as your comparison to a Government spending cut (which also removes cash from the market).

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Your scenarios would work better as well: 1. Fed offsets the contractionary effect of Government spending cuts by replacing bonds with new cash in the market (subject to Liquidity Trap objections). 2. Government spending cuts are reassuring to private capital holders, who offset spending cuts by releasing excess cash into the market. Of course, the real difference (at least for domestic U.S. conditions) is that QE and regular Fed operations get cash into the hands of people that are hoarding it (banks, et al.) as reserves, whereas Government spending gets cash into the hands of people who are actually continuing the spending chain (well, whatever makes it past cash heavy corporate pockets). In this case, situation #1 becomes unworkable because the Fed reaches a different audience than the Government so long as bank lending is locked and situation #2 makes the leap that what is causing banks and corporations to sit on cash is Government spending, even though the former came before the latter ever occurred. Just a thought. Reply August 03, 2010 at 05:04 PM DrDick said... Sorry, Brad, but the pain caucus are not interested in "facts", they just want to insure that the rich never have to pay any taxes ever. Reply August 03, 2010 at 08:28 PM mike said... You're making sound intellectual arguments. But you're making silly typos (yeah, I do this too, but I feel it helps when people point it out to me; for example "coat" instead of "cost" and "Bit" instead of "But." And, more importantly, it may be too intellectual. Not in content, but in style. That is, I suspect it's a little hard for any but the most sophisticated readers to unpack what you're saying. Or at least that is what I would guess. Maybe try the ol' half-as-long trick. Or find that just-so analogy. Yes, these folks are insane. But given they are insane I think it is important to work to make that insanity as plain as the light of day, even to people who never took a course in economics. Still, much better than I could do. The world needs people like you in times like this. Maybe start with the conclusion. Conservative economists say (a) nobody knows what's going on; (b) it's so complex and unprecedented; (c) one would have to be arrogant to give policy advice in such circumstances, and therefore conservative ideology is the right way to go. Is this not transparently disingenuous? Especially given (a) a lot of people *did* call this from the beginning; (b) it's not unprecendented; (c) there is little more arrogant than assuming your ideological leanings are the correct default option. Reply August 03, 2010 at 10:31 PM Comments on this post are closed.

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Joe Miller: 'There should not be' a federal minimum wage

economics DeLong

Me:

Washington Post - Oct 04, 2010 By Matt DeLong In an interview with ABC News and Politico, tea party-backed Alaska GOP Senate candidate Joe Miller stood by some of his most controversial ... Related Articles » « Previous Next »

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Absence of Evidence for the Pain Caucus Case - Grasping Reality with Both Hands  

Absence of Evidence for the Pain Caucus Case 10/23/10 5:39 PMAbsenceofEvidenceforthePainCaucusCase-GraspingRealitywithBothHands But I cannot...