Dramatic spending cuts

by Russ Roberts on February 20, 2013

in State of Macro, Stimulus

Today’s front page Washington Post story on the coming budget cuts says that government will have to “dramatically trim” spending. The cuts I read about amount to $1.2 trillion over ten years.

On the surface, $1.2 trillion is a large amount of money. But when you divide by ten, the number of years, you get $120 billion. That is not large relative to a $3.7 trillion budget. Those are not dramatic cuts in the overall level of government spending.

Macroeconomic Advisers, an independent economic group, said Tuesday that sequestration would cost 700,000 jobs and push the unemployment rate a quarter of a percentage point higher than it otherwise would have been.

The group said in its analysis that the cuts would be a significant economic hit, given that taxes have already gone up this year and “with the economy still struggling to overcome the legacy of the Great Recession.”

Can you imagine forecasting the job impact of a cut in government spending of $120 billion? The prediction–a loss of 700,000 jobs–is unverifiable. It is the result of a complex econometric analysis on past relationships that presumes that those relationships will continue to hold. There is no reason to think that that will be true. Believing that would require believing that you have measured everything that matters and correctly modeled how those factors interact. I don’t believe that is possible. So there is no way to verify the prediction. In an economy of 134 million employees, 700,000 is again, close to a rounding error. We can’t estimate the effects of government spending with anything close to that level of reliability. Too many other things are happening at the same time that we cannot measure.

Here is what the Post should have written:

Macroeconomic Advisers, an independent economic group (that leans Keynesian and interventionist but isn’t part of any political party explicitly at least) said Tuesday that sequestration could possibly lead to 700,000 fewer jobs if all the necessary assumptions and relationships observed in the past turn out to be true. Economic groups such as the Congressional Budget Office and other forecasting firms that used similar models to forecast the future were unable to predict the Great Recession or accurately estimate the impact of the stimulus package of 2009. But maybe they will be right this time.

By the way, Paul Gregory says they aren’t really cuts at all. Wouldn’t be the first time.

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