CBO estimates

Prof. Roberts: Economics necessarily involves that which is not seen as well as that which is seen, as Bastiat points out. And the cost of an action can never be realized, as Buchanan shows us. The use of a model or theory is inescapable in economics... "what *didn't* we see," "what *would* have happened," etc.

So CBO's approach *is* an analysis of what stimulus actually did; such analysis necessarily requires a counterfactual, based on an underlying model of what would have happened otherwise.

So while we might disagree with the neoKeynesian underpinnings, this is an argument about the best macro model. So... what's your alternative model? And could you suggest an alternative approach to gauging the effects of stimulus?

"But those who defend the stimulus have no empirical support either. The CBO “estimates” are not an analysis of what the stimulus actually did but rather what some predicted it would do. "

Right, but where did they get those predictions? Where did we get a 1.56 multiplier that we keep hearing about? It was from empirical estimates from earlier periods, right?

Generally I agree - developing the counterfactuals to test fiscal stimulus is very, very difficult and tentative and nobody on either side should claim strong empirical verification. But that doesn't mean the multipliers the CBO is using were pulled out of a hat either.

I feel like the logic is on the Keynesian side and the sparse, tentative empirical evidence points that way too. I really don't see what there is opposing it. Bad logic and Barro's estimates which are applied out of sample is about all, from what I can tell.

By you in the previous comment, I meant "one" not you, per se, Daniel. Sorry about that syntax. I simply meant to say that the range of estimates tells us very little about stimulus, especially since the estimates from the past may not apply to the current economy.

True - the range of estimates alone doesn't tell us anything. But if you look at how Barro got his estimate and how Bernstein got his estimate (although I think Bernstein just got it from someone else - he didn't come up with it like Barro did), then you definitely learn something (just nothing absolutely conclusive!).

Let me phrase it this way - I agree that estimates from the past may not apply to the current economy. But who's past conditions used to derive the estimates better approximate the current situation in your opinion - Barro or Bernstein? That line of questioning can be very fruitful.

Don't you like the 1.5 number better? Doesn't it just feel right?

Daniel,

Stop being cryptic and just throw out the atypical line about how fiscal multipliers are magically higher in times where MPC is most likely low and demand for money holdings aught to be considered higher. There are faults in Barro's work, but the argument you are insinuating is not the reason we should be wary of his work (what spending he is measuring largely explains the small multiplier).

I'm not even sure about your concluding parenthetical, although I've heard some people make that argument and I guess it might make some sense.

I'm not finding fault in Barro's work or even really his multiplier. I think it's a very plausible multiplier under certain conditions. What I'm primarily concerned about is how he cites that work in his WSJ article.

Barro mostly uses military spending calculations does he not? Why wouldn't arguments what military spending is diffused through the system through a much different mechanism than say UE benefits, or subsidies to schools, be shaky in your view.

What certain conditions, exactly, are you talking about? Again, you are using vague language.

Well like I said - it does make some sense that that would be a concern. It's just not my primary concern with it. Military spending still stimulates output - it's not like a tax cut where a large portion might be saved. It's certainly a less balanced, more distortionary type of consumption than what you would get from unemployment benefits - but it's all consumption nonetheless. Plus, I think a lot of the purpose of deficit spending specifically is to help the loanable funds market clear - and military deficits are as good as any other deficits for doing that. Plus, I agree with Barro that it's a very nifty way around the endogeneity concerns. So it has some liabilities, but I don't think it's particularly horrible.

What bothers me more is that the estimates are produced for periods of growth and for periods of recession. The brilliance of Barro's piece - that he can deal with the endogeneity concern - is also its downfall because it is precisely when the economy is weak that we care about how big the multiplier is. There's also the question of the liquidity trap, which is obviously a lot more tentative and disputed. But, insofar as we buy into that concern, that doesn't simply make Barro's estimates faulty because they don't always happen in recessions - it makes them faulty because they happen in recessions without a liquidity trap (which presumably would have smaller multipliers than recessions wiht a liquidity trap).

You're always going to have tradeoffs in empirical work. Barro had the choice between a less than ideal kind of spending and a very interesting way of getting around the identification problem for multiplier estimation, OR a more ideal kind of spending that didn't really solve the identification problem. I don't fault him at all for making the choice he did - it's the identification that is the biggest obstacle to producing reliable multipliers. He moved the field forward by providing something of a solution to that problem. He just needs to be a little more cautious in his interpretation and generalization of the results.

Why would multipliers be larger during a liquidity trap? Seems to me the monetary effects of a fiscal stimulus would be weaker assuming a liquidity trap. More plainly, if, for whatever reason, businesses are unwilling to loans at a near zero rate, why would we expect multipliers to be higher during this period than they would be under a period where businesses are responsive to interest rates. Put another way, if business is really pessimistic (recession with liquidity trap) why would government spending be more effective under a situation where there is marginal pessimism (run of the mill recession). Furthermore, if businesses are really optimistic (say a normal growth period) why wouldn't we expect government spending to cycle through the system at much faster rates?

Likewise, are you suggesting we are currently experiencing a liquidity trap; if so, why do you think that? Explain your positions a bit further if you would.

I'm not sure I follow. Why do you think multipliers should be smaller in a liquidity trap? A liquidity trap suggests that savings are being underutilized, depressing output. That suggests that capacity is being underutilized. When credit and capacity utilization are low you don't expect crowding out with additional spending - no crowding out means that less of the normal multiplier is eroded away than would be the case in a full-employment economy when we would expect to see crowding out.

As for whether we're currently in a liquidity trap, I suppose it depends on how we define liquidity trap. It has been defined several ways. Short term interest rates cannot adjust down to what the real, market interest rate would need to be for the market to clear. That suggests that there is excess liquidity. This is one very common definition of a liquidity trap. If that's what we're talking about, then yes, I think we are in a liquidity trap and I think there are consequences to that. If you're talking about a more old-school version of the liquidity trap, with inelastic demand for money, I'm more agnostic on that. That obviously doesn't require zero interest rates (although it does imply very low interest rates), and with issues like real balance effects I'm not sure how important it actually was (and neither was Keynes, for that matter). So I suppose it depends on what you mean.

Now why do you think the multiplier would be smaller in a liquidity trap? I've heard people say the liquidity trap is bogus, and I've heard people say that the liquidity trap is real and monetary policy is ineffective, but I've never heard anyone say both that the liquidity trap is real and that fiscal policy is ineffective in such a situation.

I like how you said depends on how you define it. My take away is that it's highly subjective. Since there is no objective measure to whether or not we are in a liquidity trap, if it exists and I'm on the no side, then we can't "assume" we are ever in a LT. That's the same kind of a blind assumption like Government loves us and will only spend money to help everyone equally. Say it all you like, you can't prove it so you can't assume it.
Since most Stimulus proponents depend on a liquidity trap scenario as a justification for more stimulus, it's a bad argument on it's face.

As an aside, not directed at you Dan, it amazes me how modern macro uses the "show me the empirical work" as a criticism of Austrian theory, but doesn't follow their own advice on LT or Paradox of Thrift. I keep hearing, well it's an empirical question, but no one wants to do the empirical work.
It's as if they don't want to go through all the work to find out in the end that they are advocating leeches to hemophiliacs.

And to add, when someone does the empirical work like Barro but doesn't get the answer that the "consensus" wants, Barro just gets all sorts of ad hominem thrown his way. Not you, but have you read DeLong talking about Barro ever?

I don't think it means that it's highly subjective - what it means is that the term has been used in no less than three ways. I wasn't sure if Ryan was talking about Keynes's liquidity trap, Hicks's liquidity trap, Klein's liquidity trap, or the Krugman/Japan liquidity trap. I think we are obviously in a liquidity trap of the last two versions, and that it does have some implications. I think it's less obvious that we're in a Keynes/Hicks liquidity trap (which is in some ways the more theoretically interesting version - although probably the less practically important version). All of these versions are related, but they all require a slightly different answer to the question.

That's the problem, isn't it, Danny? Even if the multiplier were different under different circumstances, you never really know what circumstances you're in until well after the fact. And often, not even then. Yet, you compel millions of people to fund your stimulus.

One would think you'd need a more compelling argument than "we're guessing" to force stimulus on people.

There isn't really a problem though, we have data on spending and savings during this recession. From that data we can make conclussions about MPC. We also have data on investments. If we have a decent idea of what mupltipliers are during normal times, using evidence about investments and MPC we can at least make an argument for a higher or lower fiscal multiplier during recession. From what 've seen savings are up (which could just be a statistical parlor trick) and investors are cautious; this leads me to beleive multipliers should be revised downward, not upward.

From what I read, savings is going down. I think it was from a Financial Times article but I don't remember. Point is, who's right? It's probably all a statistical parlor trick and we are all marks.

The multiplier ranges from .4 to 1.56.

Guess who likes .4--Barro.

Guess who likes 1.56--Bernstein.

What have you learned? Nothing.

If you don't know the inputs, what use is a model?
If you don't know the inputs, how could you know the outputs? Then how are you ever supposed to validate the model?

1. The outputs are given (dictated by the chief political boss).

2. The model is used in reverse to determine which inputs to use to get the correct outputs.

3. Validate? Oh come on. Keynesianism just makes sense.

Keynesianism is "settled science" like AGW.

And I'm nothing but a denier--a puppet of some greedy special interest.

That professor Krugman is really smart and he said that deficit spending is a good thing, so it MUST be a good thing.

Those IPCC scientists are really smart and they said governments need to control human behavior blamed for climate change, so we MUST give them that power.

The new Divine Right of Kings.

I would like to see a graph of historical CBO estimates between 07 and now. I recall the CBO estimating that the worst unemployment rate we would see would be around 9% and we would be recovered by now. To me that either means that the stimulus didn't work or that the CBO estimates are only worth the paper they're printed on, or both.

Did the CBO provide an estimate of the U.S. unemployment rate? I thought that projection was provided by the President's Council of Economic Advisors. The CBO cost estimate of the American Recovery and Reinvestment Act of 2009 - was a projection of only the incremental impact of the Act. The CBO did state:

"CBO anticipates that implementation of H.R. 1 would have a noticeable impact on economic growth and employment in the next few years."

However, I could find no projections for future unemployment rates or timing of recovery.

I actually appreciate the work that the CBO does. And as someone who works on financial models regularly, I understand that you'll never be "right".

But you've got to take the model for what it's worth ... a projection of potential cash flows that will play out if the world continues to work in the way that you currently understand.

The problem with the CBO is two fold:

One, people take their projections for truth and fact. Not exactly their fault but they could probably do a better job of explaining that they don't know what the hell they're talking about because;

Two, their projections often involve the cost / benefit of future regulation and programs. It's damn near impossible to forecast the unintended consequences of new rules that you're throwing against business and the public at large.

"I’m skeptical on logical grounds..." R Roberts

I'd be curious to here the logical argument. What I've heard is that public debt displaces private investment. But that's not a logical argument in that it's an empiric argument that should have empirical backing. It doesn't have any backing.

My logical argument in favor of the stimulus working are two-fold. First correlation with empiric evidence. GDP, the Dow, employment numbers and other economic indicators are trending in the right direction. As they did in FDR's times. Like climate change it's be harder to support my argument if the climate trend was one of cooling or if the economic indicators were all still heading south. My arguments, as they often do, leaves the other side reminding me once again of the importance of understanding that correlation doesn't prove causation. I love getting such reminders on such a regular basis.

Second, purely logic based. If the government prints $1 trillion dollars and invest it over 3 year to building roads, funding collage education and transforming health insurance jobs into health provider jobs and pays for it taxing newly found sheltered money in Swiss Banks accounts I see no way this would NOT stimulate the economy.

Would you explain how this: "...I see no way this would NOT stimulate the economy" can be construed as logic based?

Where does that money that government spends come from? Do you really need empirical evidence to determine that it either comes from current taxes or future taxes - and that taxes are resourses that are pulled from the private economy?

"If the government prints $1 trillion dollars and invest it"

Why not just legalize counterfeiting for 2-3 months, or however long it takes to print up $1 trillion? And if that works, why not just permanently legalize counterfeiting? Let people simply print all the money they want. To make it more efficient, just pass a law saying that all play money is also legal tender.

Just think of all the investment.

The amount of money printed needs to be linked to true productivity. What the private banking institutions have done was to co-op the government to print money for their anti-productive financial wealth stealing products.

"The amount of money printed needs to be linked to true productivity"

Even if that were true, what makes you think the Federal Reserve's printing of the money accomplishes that goal better than anyone else's? Wouldn't it be easier just to legalize counterfeiting for sufficient time to print the money you think we need?

You're assuming that what the government does has value. You say that "building roads, funding college education, and transforming health insurance jobs into health provider jobs", are "investments". The way I see it, these are "investments" only in political empire building.

When Yasafi first came to this Cafe, he believed that the building of roads was eeevil because those roads would allow people to drive to Wal-Mart. (I kid you, not!)

No Randy I'm pretty sure most trucking companies and the companies that rely on them to ship their products over the interstates have their profitiability imporved BECAUSE of the government roads.

Dude, those trucking companies are the reason we have government roads. Rather than pay for the roads themselves, they convinced the government to make us pay for them, so of course they profit. That doesn't mean its the best method for us. And there are many, many, possibilities that have been elimated.

...make that "eliminated".

Some say that building roads is an investment.
Judging by the condition of local roads, and the fact that my local government is unwilling to spend money maintaining them (I don't know if they are waiting for a check from the feds or if social programs are a higher priority), I'd say roads are a liability.
Heck, round here the only road where you can be guaranteed not to get a blowout from a pothole is a toll highway.

If state and local governments didn't have a bizarre aversion to borrowing when revenue falls short, you might not see this problem as much. Dysfunctional toll road managers will be punished by the market. Dysfunctional state and local governments have some insulation from that. But that's not an argument against functional state and local governments, nor is it proof that toll roads would satisfy all our infrastructural needs.

Another example of the counterfactual argument for government ("if it wasn't done our way things would be worse"). And again, just as easy for me to say that we would have something better. The only fact is that the annexing of transportation networks by government has removed other possibilities.

No - I deliberately didn't say "would" I said "might". I'm not claiming fool proof evidence, I'm cautioning JohnK against claiming too much. When a dysfunctional government doesn't accomplish at task, it doesn't prove that government is wrong for the task any more than the fact that there are dysfunctional private firms proves that private firms aren't up to the task. Weeding out dysfunctional private firms is of course easier than weeding out dysfunctional governments, but that doesn't change the point that you shouldn't claim too much.

I'm not seeing how private companies have anything to "prove" at all. Either their customers pay them enough to stay in business or they don't. There's no need to make claims one way or the other. It's only the political types who have a need to make such claim - because, as long as they are forcing people to pay, they have no way to prove that what they do has value.

I was using "proof" in the sense of "evident truth for an onlooker" - not anything that private firms are seeking or need to make a claim to.

But yes - I've made precisely this point twice now. I agree. The market selects out dysfunctional firms. There is no such mechanism that consistently selects out dysfunctional government (elections and the courts help a great deal of course, but still leave a lot to be desired). It doesn't change the fact that simply pointing out the dysfunctionality of a government does not demonstrate the general dysfunctionality of government. But I agree - as I said, I already made precisely this point that you're making.

There is no such mechanism that consistently selects out dysfunctional government

I think that the press at one time had that task, though now the media seems to be another branch of dysfunctional government.

Every government with the goal of total control needs propagandists.

Round here they (I say 'they' because I vote against all bonds as a matter of principle) pass hundreds of millions of dollars worth of bonds every year in the name of roads, but for some reason the money seems to get spent on something else.

Muirgeo,

Let's take your "pure logic" even further. Why stop at $1 trillion? Why not print $10 trillion? Would this stimulate the economy even more?

Because they haven't sheltered THAT much to pay for it and its not needed to that degrees as properly done private incvestment will take over os demand picks up.

Reductio ad absurdum doesn't make much sense when we're dealing with convex preferences or concave technologies. That's why most reductio ad absurdum arguments put forward on here fall pretty flat. It's not a rhetorical strategy that's particularly well suited to economics.

The problem is 50 years ago, suggesting that the government should spend $1 trillion would have been a reductio argument, now it's reality. In 20 years, you don't know, there very well could be proponents out there calling for a $10 trillion stimulus. It's obvious that the people running the show do not care for how the recessions start, just how much can they inflate their way out of them. Over time all the malinvestments are cumulative, they require liquidation, but won't get it because of government interventions. But the Government can't legislate away a bad investment. Eventually the someone has to pay the piper. Either do it now, but it will hurt or push it off until later so it's even worse and will hurt more. Politicians, wrapped in General Theory constantly do that latter.

As for your first two sentences, you need to (1.) think in real, not nominal terms, and (2.) recognize that the economy is growing: http://www.usgovernmentspending.com/us_20th_cen...

I'm not going to engage the rest of the paragraph except to say that there is definitely substance to the idea of liquidation of malinvestments, but that I think you're taking the case too far, and you're completely misunderstanding the policy recommendations coming from the General Theory.

Yes I'm quite aware of counting for inflation. The problem is, when talking about stimulus hardly anyone ever does.
Did anyone count this ARRA in 1950's dollars? No
In 20 years will they talk about their stimulus in 2010 dollars? No
They always talk in nominal terms.

Ha ha okay Dan, I'm sure your too busy to engage in the rest.

Make sense of it then. If spending is stimulating why isn't more spending even more stimulative. Maybe you don't want to engage the question because deep down in places you don't want to talk about you know that the tradeoffs, on net, are destructive.

I thought I did answer that. Convex preferences. You can't just pretend that going from $0 to $1 trillion of deficits is going to have the same effect on bond markets or the same effect on people's spending habits than going from $9 trillion to $10 trillion. We know people have convex preferences. We know there are diminishing returns to productive technology. That kind of "I can just imagine any huge number I want" version of reductio ad absurdum is illogical.

When reductio ad absurdum is correctly used it's used with full knowledge of the parameters of the system that you're talking about. Otherwise it's just hyperbole.

Think of it this way - I spent five dollars on a Chinese food dinner last night. Would you be justified in saying "well if you really enjoyed that why don't you spend $10,000 on Chinese food tonight"? Of course you wouldn't. That's ridiculous. It's precisely the same reasoning that makes Biomed Tim's "argument" nonsensical. I am engaging the question - I engaged it the first time. But hopefully this response is somewhat clearer.

"Maybe you don't want to engage the question because deep down in places you don't want to talk about you know that the tradeoffs, on net, are destructive"

At $10 trillion dollars I'm confident the net tradeoffs would be destructive. That's why you've never seen me advocate anything close to a $10 trillion stimulus. But you should be careful not to think that the net tradeoffs are proportional to the size of the stimulus. They're not. (again, convex preferences - concave production technologies).

Yes, that is more clear. But the same economic theories that you apply individual preferences/habits and diminishing returns have got to come into play when discussion leads to where the government is getting the money to 'stimulate' with. Those resources come from somewhere and the same alteration in preference sets and the same diminishing returns rear their ugly head but this time they do it with the two added 'benefits' of misallocation and bureaucracy in the mix.

Yes - couldn't agree more. I'm glad we're on the same page.

Now you're just being ridiculous BT...

Exactly. Unfortunately, the $10 trillion figure seems to be closer to the actual plan.

What if instead of the US government it had been, say, Caterpillar who had spent all that money. Would that not have created jobs? Would that not have generated economic activity??
I don't see how the analysis changes with the identity of the spender.....
even more so during a recession

If we assume that Caterpillar is a well managed company, adequately capitalized, and current in debt servicing obligations, what would be the effect of its spending reserves or worse, borrowing against its productive capital base to expand production in a down market? Would this action "stimulate" the purchase of new road graders, front end loaders and track hoes? NO, because the market for such equipment is being met by current production. It would create jobs for the duration of additional production and affect demand for higher order commodities required in the course of that same time span, but the result would be a storage area full of heavy equipment which would remain until such time that the company sold the equipment ata severe discount or loss.

This has two effects. First, it signals their suppliers that demand is elevated and so they, in turn, expand production by way of reserve expenditure or, more likely, credit access. Second, it consumes commodity resources which would go to other enterprises, temporarily (and artificially) increasing prices within those markets. It creates economic activity for which there is no demand and thus, any benefit would be shortlived. Moreover, it jepardizes the very existence of the company and,perhaps, that of their suppliers. Put simply, it burns capital.

Decades ago, the Soviet Regime saw a need for greater tractor production and so diverted resources toward that end, and with the result that they thereafter propogandized that they were the greatest producer of tractors in the world; this while crops rotted in the feilds as they lacked the harvesters needed to get the grains to silos. The United States sent millions of tons of wheat and famine was averted. Who is going to send US the wheat when the financial manipulations come undone?

"Would that not have generated economic activity??"

If that investment in Caterpillar was such a productive one, then why did the government have to do it? Wouldn't the people who loaned the government that stimulus money be interested in a ROI from Caterpillar? Are the smartest investors in government?

It is easy to generate economic activity by spending money. But economic activity can just as easily be destructive as productive of human wants.

You can pay someone stimulus money to tie knots in thread all day, but what a waste of that person's time, what a waste of thread, and what a waste of money! That economic activity is both a direct and opportunity cost, even though the worker may be a skilled and conscientious knot tier. And that is only the beginning. The demand for the thread wasted resources in the thread making industry as well, including that industry's suppliers and investors.

And since knotted string was made for political demand, not market demand, what happens when the stimulus ends?

The result--the stimulus spending destroys wealth and drains the economy. And when the stimulus ends you not only have a poorer economy, but you lose that economic activity as well (activity which was an engine of destruction). You wind up with much less than you started with.

"If that investment in Caterpillar was such a productive one, then why did the government have to do it? Wouldn't the people who loaned the government that stimulus money be interested in a ROI from Caterpillar? Are the smartest investors in government?"

um. no. But you see, in a financial crisis the risk (and therefore price) of financial assets rises. financial institutions also have their balance sheets severely affected. that is why lending to private institutions dramtically falls, even to strong enterprises. it is self evident that that has happened
so the government, whose spredas HAVE NOT increased, can fill that void (and there is a void, look around). and it should fill it in order for the flow of nominal spending not to plumbet
of course government cannot have ALL the information the private sector (in a descentralized way) has. but flows in nominal spending, falls in velocity, can be very very harmful. there's no denying that, is there??

"falls in velocity, can be very very harmful. there's no denying that, is there??"

Of course there is denying it. If velocity drops because of a drop in opportunities for productive spending, then trying to artificially prop up the velocity metric is not going to increase opportunities for productive spending. If a bridge crumbles away under your feet, do you think the bridge will reassemble itself if someone gets a crane and suspends you back over the bridge's prior span?

Pushing those macro aggregates around is NOT economic thinking. Keynesiacs do it all the time, but they are not economists. They are worshipers of animals from the spirit world--since it is those animal spirits in whom the fate of the economy supposedly resides. The worst thing is that what the keynesiacs offer up for sacrifice is not just a rain dance, but REAL capital in the real world. And they destroy REAL lives in the process.

Vike,

Right on! You're a real economist, for sure!

"the government...can fill that void"

um. no. The government most definitely CANNOT fill that void. Opportunities diminish, but so do balance sheets--diminished investment funds and diminished opportunities--interesting coincidence, no?

The fact that an investment is risky does not go away just because the government spends investment money instead of the parties from whom the government borrowed that money. Nor does flushing real capital down the toilet of wasteful enterprises help build a depressed economy. And flushing it is all the government CAN do, unless by accident, since the much better motivated private investors would've likely already snatched up those desperately rare opportunities instead of lending the money to government.

Your idea does not work. Not in reality. Not in any rational theory.

It is the same money being spent. You would have government take it and squander it all now, rather than have the holders keep those funds, spending it only when their expert eyes find a potentially profitable investment.

I don't blame you for this idea. It is thoroughly keynesiac brainwashing, and is one of the most absurdly preposterous notions to ever pollute the expert minds of academia. It has destroyed the field of economics, and turned the Nobel Prize into a dunce cap.

So we're supposed to engage in destructive policies because "nominal spending might fall in velocity"? You can't possibly be serious.

in the second to last sentence that should be: "but falls in nominal spending..."

This is how I understand the theory; If Caterpillar, and others like Caterpillar, decide for some reason to stop spending as much money as they have in the past, thus employing less people, thus holding unused capital and creating unemployed human resources, then those who claim to speak for "society" ( i.e., the political class), feel justified in confiscating the unused capital to employ the unemployed human resources in the interests of the "society" they claim to speak for.*

The problems are; 1) Caterpillar and the others like them lose the ability to apply the capital when future profitable opportunities present themselves, and 2) Those who claim to speak for society (i.e., the political class), don't really speak for society but only for their own interests. Thus the effect of the theory in practice is to transfer capital and human resources from the productive class to the political class, which is of course an unsustainable trend, which must eventually lead to a condition at least as bad and probably worse than the situation which was used to justify the transfer.

*I am ignoring the justifications themselves, e.g., the multiplier, because I see no evidence that they are true.

Yes, the analysis does change with the identity of the spender because the incentives change with the identity of the spender.

When Caterpillar spends, its incentive is to invest to create more wealth. Moreover, Caterpillar acquires financing for these project by issuing stock or bonds to voluntary investors. It invests this money in a business in which it is the expert. Caterpillar doesn't invest in, say, restaurants.

When politicians spend, their incentive is to pay off whatever political favours they owe. Wealth creation doesn't even factor into it. Politicians acquire funding for these projects by force from taxpayers. Even if a politician or group of politicians may truly want to invest where wealth can be created, they simply doesn't have and can't acquire enough information to know where that is. That would require an unattainable level of expertise in a too vast a number of subjects. Is it any wonder that the Keynesian multiplier is a fraction?

Government enterprises cannot succeed because they are not allowed to fail.

Are you aware that the US government is currently being able to borrow at practically 0% interest rate?????
does that sound like its forcing to people to lend it money??

I've heard the near 0% interest rate statistic used to argue several points: the market is assuming no (or low) inflation, the market thinks lending to the gov't is safe, etc. Yet this rate only exists because the Fed artificially increases the demand for gov't debt through its open market operations. If this rate is managed by the gov't, how can it be a reliable price signal for anything?

You've got this backwards. The Fed followed Treasury rates down to zero, not vice versa. It's for that reason that some people (Scott Sumner) even considered monetary policy to be somewhat tight in the fall.

I'm confused here, maybe you can help me out. My understanding is that the Fed purchases Treasury notes in the open markets, increasing the demand for them and therefore driving up the price, which by definition decreases yields, or rates. In what sense are they following rates down?

All I'm saying is that yields on Treasuries grazed and then stabilized right above zero a couple months before the target federal funds rate went down to zero. So yes, Fed purchases and sales are going to influence the market, but in this particular case it wasn't the Fed that artificially pushed it down to zero. The fact that we've been churning out spending without market rates budging suggests that the market price is down at zero - the Fed isn't keeping it there. If you saw short term market rates (any rates really - not just Treasuries) starting to rise consistently above the federal funds rate, I think I would worry about that too. I just don't see it right now under current conditions.

It's an interesting question that you raise about the purchase of Treasuries as a direct effect on the market for Treasuries. Usually (I believe), the logic is that the Fed will buy securities to create bank reserves, which expands credit. What you're suggesting is that they buy so much that it drives up demand in the market for Treasuries, more as a direct effect on that market than as an indirect effect on the money supply. I simply don't know enough about monetary policy to say. I don't know if they purchase enough to really make a difference in the market for Treasuries. If they did go on a shopping spree, simply buying up government debt that would be an example of "monetizing the debt", and it would not be a good thing. But I'm not sure reserve creation quite amounts to that.

If you have reason for thinking differently or any other insights, please let me know. Monetary policy is something I've developed a deep interest in since the beginning of the crisis, but it's still something that I don't know too much about formally.

But We are at the ZERO BOUND, regular economics doesn't make sense!!!!

Zero bound doesn't have much to do with whether federal funds rate targeting impacts the market for treasuries, does it? What changes at the zero bound?

That was me being like Krugman.

Nothing changes at a zero bound because LT isn't a valid assumption.

Clearly zero bound has no impact. See, here I draw an X in quadrant I. Now watch as I move that X down to the x-axis... now onto the x-axis... now below the x-axis...

See! The X does not change shape! Quod erat demonstrandum.

I think this is ready for NYT publication. Hey, maybe I'll even get a Nobel Prize!

Sorry, didn't have time to properly read your response earlier. I think I see the distinction you're making now--basically the idea is the Fed buys enough Treasuries to increase the supply of reserves and influence the Fed Funds rate, but not enough to have a significant effect on the overall Treasuries market.

My thought is that these rates have to be inter-related, because they are in competition with one another. So when the Fed creates bank reserves to expand credit, some of that goes to pushing down the Fed Funds rate, some to Treasuries, and some to other lending. I guess the difference is whether the Fed buying affects the Treasuries market directly or indirectly, by creating the money that is then used to buy Treasuries. In practice, I'm not sure this difference matters, since in either case it is the Fed's actions that push the yields down. And as long as Fed monetary injections push down rates in general, I can't see how they can be viewed as market price signals.

That being said, the point you raise about the rates relative to one another is an interesting one, since it has implications about how the market is evaluating the relative riskiness of the different types of debt. Thanks for your response, this is definitely something I'm going to have put more thought into.

Ya - that first paragraph summarizes my understanding of open market operations. But I take your point as well - it HAS to impact the Treasury market to some degree. I just don't know how much. That's really an empirical question.

My intuition is it probably doesn't impact the market for Treasuries that much. I say that because people have suggested doing it to deliberately influence the market for Treasuries: the people advocating "quantitative easing". And most establishment types in the Fed and among economists flipped out when that was suggested. That suggests to me that the scale at which Treasuries are normally bought and sold is big enough to shift reserves in a decisive way, but is a drop in the bucket when it comes to the Treasury market. But if you ever find out more about the issue I'd be very interested in hearing what you learn.

I did a quick google search and found the following:

According to wikipedia, as of 2008 just under 50% of all Treasury securities were "Federal Reserve or intragovernmental holdings."

http://en.wikipedia.org/wiki/File:Estimated_own...

And according to a Sep 09 WSJ article, "In the second quarter, the most recent for which data is available, the Fed bought $164 billion out of the $339 billion in net new Treasurys sold."

http://online.wsj.com/article/SB125348691921426...

My feeling is that level of participation should have a pretty significant direct impact on the Treasuries market.

Oh wonderful! Thanks Allen.

I think we need to be careful with the first citation. I could be holding a billion dollars of Treasuries, but if I'm not putting them on the market it's not going to impact fluctuations in the price of treasuries, right? It's akin to the Fed's "sterilization" of the gold reserves in the 1920s, simply by piling up gold in their vaults and then not doing anything with it. Changes to those holdings will, of course, but I'm not sure how much of those holdings are simply held. The more important one seems to be your second link, which does suggest that the Fed is active in buying up Treasuries at the moment.

Interesting - like I said, a lot of this is new to me - I'll keep my eye on this.

I'm no expert on monetary policy, either, but as far as I know "open market operations" (the buying and selling of treasuries in the open market) is historically how the Fed influences rates to achieve its target. I say historically because it looks as if Bernanke has a new tool in mind--adjusting the interest the Fed is paying on excess reserves to influence rates.

Juan, it sounds to me more like the Money Factory humming along at full speed.

**** i meant: forcing people to lend it money

BTW, Jaun, the 30 year Treasury yield is 4.67% and the 10 year is 3.69%. That's not practically 0% and those rates also include inflation (or deflation, as the case might be) expectations as well as expectations of the creditors of the borrower's ability to extract enough wealth from the population to pay back the loans.

In the long run, government borrowing is just an indirect method of transferring capital and resources from productive uses to political uses.

In the short run too! Where do you think that money comes from? The dusty old government money vaults?

True dat.

Nancy Pelosi is busy handing out stimulus money to buy votes for the health care destruction bill.

Yes, it matters who spends the money.

The taxpayer is not forced to lend. The taxpayer is forced to pay off the debt. The debt that politicians acquire to pay off political supporters.

take a look at how "stimulus" money is being spent.

Its a counterfactual argument, and therefore not logically true.

But it occurred to me the other day, that the government itself is a counterfactual argument, "if we weren't taxing you then something worse would happen". Again, not logically true. I can just as easily say that if they weren't taxing me then something better would happen.

Yes, but THEY have a MODEL!

No they have a PLAN!
And it includes taking everything you own and redistributing it all to those they deem more worthy.

calculating the effect of the stimulus is only good if used as an indicator of assessing the impact of exiting. I do not see any other use of it since the Fed has decided to start stepping aside and let the market operate on its own again... In any way, nobody can argue the stimulus did not help. Throwing a trillion or so in the economy must have helped at least in decelerating the downturn, kind of insulating basic industries from straight out collapse. The question of creating new net jobs is also out of question: It did not. You just need to look around you to realize that...

"nobody can argue the stimulus did not help"

Nobody can argue the stimulus did not help SOMEONE--the direct recipients of the funds. But the argument has been made that such actions can HURT the economy on net, even accelerating a downturn.

A trillion dollars of government spending means a trillion dollars less of self-interested economic decisions, for a trillion dollars more of self-interested political decisions. It is hard to see how that advantages the economy.

And the stimulus spending in particular, as opposed to the initial "emergency" TARP bailouts, is a tough sell for having created net current economic advantage. One can make an argument that the initial TARP spending delayed or slowed some sort of shock, whether or not it was worth the cost.

This ^.

The stimulus has (probably) helped some, but it has done so at the expense of others. Cost and benefit. You can't ignore one side of the equation.

There is no free lunch.

I am wondering about the possible current effects of the trillion dollar spending. You say:
"means a trillion dollars less of self-interested economic decisions" I am assuming as Randy said above "It seems instead to be aimed at punishing future generations" you are talking about future tax increases and inflation?
Is this at all offset by the fact that interest rates are so low as to encourage many dollars spent on "self-interested economic decisions?" I guess this will also shift resources to unprofitable or unsuccessful projects leading to another hangover, but do you see my question?

"Is this at all offset by the fact that interest rates are so low as to encourage many dollars spent on "self-interested economic decisions?""

No, it certainly is not offset. It is made worse. Sustainable productive investment needs REAL capital, not just credit expansion and inflation wealth transfers. That requires real savings. But the price mechanism that tells investors how much of that capital is available, is WIPED OUT by central bank manipulation of interest rates. It certainly has been, and likely is now, the case that the interest rate the Federal Reserve creates by subsidizing its banks, is lower than would be the market rate. But whether too high or too low, it most certainly is wrong, and therefore worse than useless as a signal.

And the too low rates we've had for so long, have resulted in diminished savings--diminished real capital for investment--since the Fed undercuts depositors by giving loanable fiat money directly to the banks. Therefore monetary policy causes people to consume all their capital while simultaneously causing investors to believe the people are saving capital for future consumption.

The result is that we're broke, and investors are blinded.

"you are talking about future tax increases and inflation?"

No, Surfisto. Those are costs too, but what is so frustrating to me is that people ignore the immediate costs. People falsely think it is a party now, pay later scheme. It most definitely is not. It is a pay now, pay later scheme.

Remember that the US Treasury has ZERO dollars for deficit spending. The must acquire those dollars, BEFORE they can be spent. By definition, the dollars are not collected in taxes. A portion does come off the Federal Reserve printing presses--leading to inflation. But there are other immediate effects:

1. Investors (foreign and domestic) buy US government bonds. Those people are making a decision to put their money in the hands of the government, instead of putting it somewhere else. The keynesiacs claim that the "somewhere else" is in their mattresses, for lack of investment opportunities. But the reality is, there are always some investment opportunities now, and there will be more cropping up all the time. When the government borrows, it diverts money away from those potentially productive oppotunities--precisely the opportunities that will allow the economy to recover. The government provides an easy choice for investors, thereby relieving investors of the labor of plying their expertise and scouring the depressed economy to find those opportunities and make them work. It also depletes investors holdings, so that when opportunities occur, the investment funds are gone--already spent on Treasuries.

2. The Federal Reserve does not (or did not until recent months) use its newly created money to buy Treasuries directly. It instead buys from private institutions. Therefore, all of the money that the Fed uses to monetize the debt passes through the hands of private investors. That means much of that money actually does have access to private investment, if the US Treasury did offer preferred investment.

3. Spending can be either destructive or productive. It is possible to do worse even than simply burning the money, if instead that money is used to create money burning machines. Investment is therefore NOT a simple matter of spending. There is such a thing as negative ROI. And since the government, and not the profit-seeking investors who lent the money to the government, are spending stimulus money, it is a virtual guarantee that government spending will destroy wealth. See my reply to Randy below for more on this.


In short, for an economy to recover (meaning for people to be able to use their local knowledge to assemble into vast new efficient trade networks to achieve their ends), the economy needs productive activity to increase. But government stimulus takes money out of that productive economy and instead creates destructive economic activity. It tears down the economy right from the start. You don't have to wait for the direct taxes and inflation taxes that come later--those will be an additional burden.

On ANY time frame, government spending is a costly expense, and detracts from the economy. You don't just pay the piper tomorrow for deficit spending today, you start paying before the first government dollar is even spent.

Thank you for the reply.
So the fact that China is purchasing a large amounts of our governments debt is a bad thing (I believe it is argued as a good thing or has no consequence) because they should be investing in private organizations like W. Buffet buying a stake in GS?

Newly issued government debt, yes; that is a bad thing. In the absence of government debt ready to be purchased, China, if it really wanted to put their newly acquired USDs to work would have to purchase government debt in the seconday market, corporate debt, equities, properties, or our goods and services.

China buying govt debt in the secondary market; this is the velocity of money happening?
Sorry for late reply the most recent post brought me back to this one.

It has nothing to do with China in particular. The fact of ANYONE purchasing government debt is immediately BAD for the economy, and terrible for any free society. Having Chinese investors carefully invest their money in private endeavors, including in the US, is a good thing.

I believe I understand your points and I had not thought of this before.
So say China does not have the option in investing in US debt and buys "x" shares. It is likely China is well informed about how to invest their money and will invest for a compromise of return and risk. "x" offers more return and risk then the US debt, so while good for the US if China buys stock "x" is it good for them. I know they should be buying goods and capital for China because the dollars are likely to inflate and lose value, but don't they know this.
Sorry for late reply, the post today on cafehayek brought me back here.

Whatever Chinese or anyone else is freely doing, it is a fair assumption that they have judged it "good for them"; and who am I or you to argue with that.

They buy US Federal debt, because they judge it as good for them. They aren't judging that what the Federal government is going to do with that money is good for them, only that the risk/return on the bonds is beneficial. That is to say, buying US Treasuries isn't a vote of confidence on US Federal government spending. The Federal government doesn't make a return. The Chinese confidence in investing in Federal government debt is that the Federal government will tax its citizens to raise the money to pay them back. It is faith not in economic sense, but in the gun.

If the Chinese didn't have that tasty violent offering, they would be looking for other places to put their US dollars. If there were profitable ventures available to them, they would invest--a good thing because it facilitates economic growth. If no profitable ventures could be found, they would not invest--also a good thing, because it does not squander resources on wasteful endeavors.

Centuries ago, men with armies would raid neighboring countries and loot the people living there. Today those men just employ the governments of those countries to do it for them.

"...nobody can argue the stimulus did not help."

The problem is that it helps those who have made mistakes - those who overestimated the value of real estate, those who bought investment products based on the overvaluation of real estate, and those who are overinvested in political institutions. While it may be true that a gradual correction is better than a crash, I 'm not seeing how the current plan is doing anything like punishing those who actually made the mistakes. It seems instead to be aimed at punishing future generations - most of whom are not even related to those who actually made the mistakes. Personally, I'm in favor of making the corrections immediately. Dump the worthless assets. Let those who are in a position to do so buy up the good assets at bargain prices, and then get back to work.

Is the stimulus helping those who have made mistakes or did the bail outs help them? Or was it the in the same bill?

Both. The bailouts were most directly targeted for those who bought investment products based on the overvaluation of real estate. But the stimulus was targeted largely at government employees jobs and benefits (i.e., those who overinvested in political institutions), and much of it is designed to artificially maintain higher property values (i.e., targeted at those who overestimated the value of real estate).

Throwing good money after bad, pulling down productive to prop up unproductive enterprises, and just taking from anybody to give to another, cannot be a stimulus but only a depressant.

Lesvic's Law:

For every action against the market, there is an opposite and more than equal reaction.

No exceptions. It's the Law!

Isn't this something like assuming the can opener?

Sometimes mainstream macro seems more like shaman doing their rain dance. When it rains, they say "look we were right!"
When it doesn't rain, it's because "The God are angry we need more sacrifice!"

No, that last part isn't quite right.

When it rains, they say, "Look, we were right!"
When it doesn't rain, they say, "Imagine how much worse it would be if we didn't do our rain dance!"

Yeah yours is better.

If it doesn't rain they say it did, because the prediction model said it would.

This is quite good.

The priesthood of fiat economics.

"I’m skeptical on logical grounds"

I thought economics rejected logic decades ago. At any rate, "skeptical" is so Age-of-Enlightenment. Get with the modern program--you're a "denier".

I have Menzie as a professor. Very smart guy, but his logic (as with all Keynesians) is flawed most of the time. Keep up the good work Russ.

Russ - It's a given that the models work better than reality. Thanks for the info.