Paul L. Kasriel
Econtrarian, LLC
1-920-818-0236
December 21, 2012
Festivus Stocking
Stuffers
Since I retired
at the end of April, I have been having a lot of problems with you people. So,
as Festivus is nearly upon us, it is time for the airing of grievances. Here
are I few of mine.
Fiscal and Mayan
Armageddon
As this is being
written, both economists and other quacks are predicting the end of the world
as we know it. The economist quacks are forecasting that another recession will
occur in the U.S. in 2013 if the scheduled return to the Clinton-era federal
personal income-tax levels and if the scheduled sequestration of federal
government expenditures occur on January 1. Some other quacks are predicting the
end of times today (or is it tomorrow?) as the Mayan calendar runs out of
dates. So far, it is not looking too good for the Mayan calendar quacks. And my
bet is that if we ever get to test the fiscal quacks’ hypothesis, we’ll shuffle
them off with the Mayan quacksters.
What is the
logic for fiscal Armageddon? Let’s talk about tax increase first. I keep
hearing that if tax rates and revenues rise, there will be a huge amount of
spending power sucked out of the economy. Really? You mean that the Treasury is
going to collect all of these taxes and just let its cash balance rise by this
amount? I don’t think so. I think the Treasury is going to collect higher taxes
from me and either transfer them to you or buy something from you. In other
words, an increase in tax revenues is not going to “suck” spending power out of
the economy, but rather redistribute that spending power. Now, you may not like
the outcome of this redistribution, but don’t confuse a redistribution of a
given amount of spending in the economy with a net decline in spending.
What about the
cut in federal spending due to the sequestration that Congress voted for? Surely, that will reduce total spending in the
economy, right? Probably wrong. If the government spends less, all else the
same, it will need to borrow less. If it borrows less, those folks –
households, financial institutions, feriners – who were planning to lend to the
government will now find themselves with excess funds. What are they going to
do with these funds? There are three things they can do with these excess funds
and two of them will result in offsetting the government’s decline in spending.
One thing they
can do with their excess funds is lend them to some other entity – a household,
a business or municipal government. These recipients of funds will then spend
them, offsetting the decline in federal government spending.
Another thing
these otherwise lenders to the federal government can do with their excess funds
is spend the funds themselves. If interest rates are too low and/or the credit
risk of other borrowers is too high, they won’t lend; they will spend. This
increased spending by the otherwise lenders will offset the decreased spending
of the federal government.
A third thing
these otherwise lenders can do is simply hold more cash than they had
previously planned to do. For the nonbank public, this means an increased
demand for bank deposits and currency, also known as a decline in the velocity of money. For banks, an
increased demand for cash means an increased demand for excess reserves. If the
decrease in federal government borrowing results in a decrease in velocity / an
increase in banks’ demand for excess reserves, then, and only then, will there
be no offsetting increased spending to match the decline in government
spending.
So, logically,
there is not much of a case to expect an increase in taxes and/or a decrease in
government spending to have a significant impact on aggregate spending in the economy.
But according to the fiscal quacksters, a reduction in the budget deficit
brought on by a “tightening” in fiscal policy should be associated with slower
nominal GDP growth. Conversely, an increase in the budget deficit resulting
from a decrease in taxes and/or an increase in government spending should be
associated with faster nominal GDP growth. Thus, the fiscal quacksters would
expect there to be a negative
correlation between changes in the budget deficit and growth in nominal GDP.
Let’s go to the
tape, i.e., Chart 1. As everyone, except those with a political bias, knows,
the federal budget deficit can change because of the pace of economic activity.
For example, when the economy crashes into the deepest recession in the
post-WWII era, federal government expenditures increase because of income
maintenance programs for the unemployed – e.g., unemployment insurance
benefits, food stamps, etc. Also when the economy crashes, tax revenues fall.
So, when the economy crashes, the federal budget deficit tends to widen because
of these automatic stabilizers.
Symmetrically, when the economy booms, all else the same, the budget deficit
shrinks or, once in a Mayan calendar, maybe even moves into a surplus. If we
are going to test for the effect on GDP of changes in the budget unrelated to
these automatic stabilizers, we need to cyclically-adjust
the budget deficit. The experts on the budget, the Congressional Budget Office
(CBO) staff, are kind enough to do this for us. The red bars in Chart 1 are the
fiscal year-to-fiscal year percentage point changes in the cyclically-adjusted
budget deficits/surpluses as a percent of CBO-estimated potential nominal GDP. Whew! The blue line in Chart 1 is the fiscal
year-to-fiscal year percent change in nominal GDP. According to the fiscal
quacksters, as the cyclically-adjusted budget deficit gets smaller, i.e., the
red bar moves higher toward the zero line or even higher above it, nominal GDP
growth should weaken, i.e., the blue line should move down. In other words,
there should be a negative
relationship or correlation between these two series. But alas, we find another
beautiful theory of the economic quacksters spoiled by some ugly facts. The
contemporaneous correlation between changes in the cyclically-adjusted budget
deficit/surplus and nominal GDP growth is not
negative from 1973 through 2011, but positive
at a value of 0.3 out of a possible 1.0. The ugly facts, then, suggest that
increases in taxes and/or decreases in government spending are associated with faster nominal GDP growth, not the slower growth predicted by the fiscal
quacksters.
Chart 1
Now, you might
argue that it is not fair to expect a change in fiscal policy this year to have
a large impact on GDP growth in the same year. Policy changes might have their
maximum effect in later years. This, of course is not what the fiscal
quacksters are arguing now. They are predicting a recession in 2013 if the
scheduled tax increases and spending cuts commence and persist in 2013. But I
did test for lags in the effect of fiscal policy changes. I found that the
first negative correlation between changes in fiscal policy and nominal GDP
growth occurs after three years and
even then the absolute value of the correlation coefficient is small at 0.1. In
sum, the historical data simply do not support the view that going over and staying over the fiscal cliff will have
a material effect on the pace of economic activity.
Is Federal Government
Spending Out of Control?
That’s what I
keep hearing. Does anyone ever look at the data? As shown in Chart 2, growth in
federal government spending flared up in the second half of 2008 through early
2010. Why? Does anyone remember the $700 billion authorization for TARP
spending back in October 2008? And then there were those automatic stabilizers
I talked about earlier. And yes, there was about $500 billion of extra stimulus
spending. But since early 2010, growth in total federal government spending –
entitlements, defense, interest, waste & fraud – has been quite tame,
especially when measured against the median annualized growth in total federal
spending of 5.1%. Remember that $1 trillion reduction in spending over a
10-year period authorized by Congress back in 2011? Well, the data suggest that
this spending reduction is biting.
Chart 2
Are Banks Going to Suffer
a Deposit Outflow on January 1?
That’s the talk
around the wood stove at the general store up here in the Wisconsin tundra.
Yes, that special FDIC insurance on non-interest-bearing bank deposits is due
to expire in 2013. Without this insurance, pension funds and large corporations
are expected to pull their funds out of banks and put them in some other
federally-insured instrument, such as a Treasury bill. (Where will the funds go
if Congress does not increase the debt limit?). But if this happens, will the
banking system actually lose
deposits? Not unless the pension funds et.al. decide to hold actual folding
money. Suppose that a pension fund decides to buy a new T-bill from the
Treasury, paying for it by drawing down an account at its bank. The pension
fund’s bank does see its deposits fall, all else the same. But what does the
Treasury do with its new funds? It spends them. So, the deposits come back into
the banking system. There may be real things to worry about with regard to our
financial system, but this isn’t one of them.
Discouraged Dropouts Are
Largely Responsible for the Declining Unemployment Rate?
Again, doesn’t
anyone look at the relevant data? The BLS has a measure of the unemployment
rate that adds back in so-called discouraged workers. It is called the U-5
measure. The first measure of the unemployment rate to hit CNBC’s crawl is the
U-3 rate that the talking heads then disparage because of a declining labor
force – “thought” to be declining because of discouraged workers. I put thought
in quotes because the talking heads never look at U-5, which includes the
discouraged to see how it changed. But if they did look at Chart 3, they would
see that both the “headline” unemployment rate, U-3, and the more inclusive
unemployment rate,
U-5, both have fallen by one whole percentage
point in the 12 months ended November 12. What the talking heads fail to take
into consideration is that more and more of us baby boomers are voluntarily dropping out of the labor
force. It is called retirement. And so long as Congress doesn’t means test our
Social Security and Medicare A benefits, more and more of the luckiest
generation will continue to voluntarily drop out of the labor force.
Chart 3
Alright, now
it’s time for the feats of strength. You can pin Paul (Ron, that is), Bernanke!
