Are Keynesians and non-Keynesians moving toward a consensus on deficit reduction?
Recently I see some positive signs of consensus. Back in 2012 there seemed to be a huge split between the “deficit scolds” who insisted that we shrink the budget deficit, and Keynesians who suggested that it was a nutty idea. At the time, I was under the misapprehension that many Keynesians thought a massive and sudden reduction in the federal budget deficit would constitute “austerity” and hence would slow growth. Now that the dust has settled, we can calmly look at the data:
Calendar 2012: Budget deficit = $1061 billion
Calendar 2013: Budget deficit = $561 billion
A reduction of $500 billion in one year. I used to be under the impression that Keynesians thought this would be a disastrous policy that sharply slowed growth. I’m now happy to report that I was wrong. (Who says I never admit I was wrong?) The new, new, new Keynesian consensus seems to be that the deficit reduction shown above does not constitute the sort of austerity that would be expected to slow growth.
I was under the impression that massive tax increases and cuts in transfer spending were contractionary. Now I’m happy to report than only cuts in government consumption seem to count. (Has Christina Romer been informed yet?)
So we have a new consensus, which spans the ideological spectrum. Yes, Federal government officials, go ahead and slash the budget deficit by $500 billion in a single year by raising taxes and cutting spending. Just don’t touch government consumption. It’s OK, it won’t slow growth. Who says economists can never agree on anything?
PS. This post could be interpreted straightforwardly or sarcastically. You might be surprised to know that even though I wrote the post, I don’t know which interpretation is correct. Really. I honestly don’t know what Keynesians think of the $500 billion in deficit reduction, mostly accomplished through taxes and transfers. I welcome Keynesian commenters who will educate me on this point. (I.e., if they really don’t think 2013 was austerity that would slow growth, then we really are achieving a consensus, no sarcasm intended. It makes deficit reduction much easier.)
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25. June 2015 at 05:40
I never get a good answer on this either.
But I’m now sure that Roger Farmer is the true heir to Keynes.
25. June 2015 at 06:37
Um. You see….well, um. Being an economist means never being wrong.
Look out the window—there is hyperinflation, or runaway inflation, or deeper recessions, everything except slo-gro lo inflation.
Which proves this or that.
25. June 2015 at 07:22
If it’s not sarcastic, it means you have truly lost all respect for people who call themselves Keynesians.
25. June 2015 at 07:42
Rajat, Maybe I’m just dense, but didn’t Krugman just write a post that said there was no slowdown in 2013 because there was no austerity, if you look at the data in the right way? And didn’t he suggest that government consumption is what matters, not taxes and transfers?
25. June 2015 at 08:07
@ssumner – you know what Krugman recently wrote about 2013 yet you feign ignorance? Seems you’re constantly begging for attention from Krugman. The first time you ever publically corresponded with Krugman, after you became famous via Tyler Cowen, was a sloppy love letter in the form of an ‘open letter’ and Krugman wrote back ‘you talking to me?’ And it’s gone downhill from there.
Why don’t you be your own man, instead of looking for approval from others? As for your question, by now you should know all economists, like R. Roberts says recently, justify their theories ex post not ex ante. Including you.
25. June 2015 at 08:38
Scott, yes, but I am saying you would be paying him greater (intellectual) respect by assuming he was being disingenuous. If he wasn’t, his argument would be so absurd that by taking him seriously, you would be signalling that you thought he had lost his marbles.
25. June 2015 at 09:22
scott, are you really just trolling yourself as ray lopez?
25. June 2015 at 09:34
In the simplest New Keynesian models, Ricardian Equivalence holds, so changes in G but not changes in T affect AD (absent monetary offset). Sensible NK don’t believe RE literally, but will generally say that changes in G have a bigger effect than changes in T (dollar for dollar).
25. June 2015 at 11:16
I take it that the sarcastic interpretation is correct.
25. June 2015 at 11:17
Although a basic Keynesian economist, I tend to think it has a simple one and done situation. (Otherwise you end up like Japan although I think demographics is the main culprit.) I think the stimulus works less in accounting but more from confidence builder. It sends the message that the economy is not going to collapse any further. (Also why TARP worked, which stated which banks/financial institutions were not going to fail. The bailout worked more in speed versus anything else.)
Why did the federal budget drop in 2013 not have a bigger effect? First, wasn’t the biggest reason for this drop the increase tax collected which was not planned for? Unemployment dropped, housing prices bounced back and incomes started turning positive. And the main spending cuts were to cuts to the war efforts in the Middle East. (So it was money really wasted). And the $50B sequester was minor cuts in the economy, many of which were military spending cuts that simply put off for six months.
25. June 2015 at 11:37
‘minor cuts’.
At the time, the left assured us these were ‘deep cuts’. Everyone said so.
https://www.whitehouse.gov/issues/sequester
25. June 2015 at 13:01
I’d say it depends on two other factors: size of trade balance relative to GDP, and credit creation. A lower deficit may be adequate considering other factors, and still stimulative.
25. June 2015 at 15:25
Stocks to crash. 4th qtr. recession imminent (without intervention).
– Nostradamus
25. June 2015 at 23:42
Just one more note, Krugman also mentioned that what is important for Keynesians is rate of change (which is true, Nick Rowe also has several very good articles about this that so far had no reply). Krugman mentions that rate of change [of austerity] was the same as in previous years.
That did not sound right so I just briefly looked at the numbers and this is how it looks (calendar years):
2007 -187,94
2008 -680,46
2009 -1471,31
2010 -1275,1
2011 -1249,58
2012 -1060,76
2013 -560,57
I see quite a large change, in the rate of change, comparable to what happened during famous fiscal stimulus that supposedly saved us from the worst. Maybe he now thinks about rate of change in government consumption? This is just too hard to follow at this point.
26. June 2015 at 09:41
How much deficit reduction could be accomplished if we eliminated tax exemptions for the delusion industry?
26. June 2015 at 13:54
Ray, You and Rajat need to work it all out.
Rajat, Well that’s an argument I hadn’t heard before. 🙂
Ben, I’m not creative enough to come up with Ray. His mistakes are often laugh out loud funny.
Nick, That makes sense, but of course it’s also true of the old Keynesian model. Basically they need to get their story straight, does sudden and dramatic deficit reduction hurt, or doesn’t it?
E. Harding, I honestly have no idea which one is correct. Rajat says Krugman clearly doesn’t believe what he’s saying. But how can I know that? I tend to take people at their word.
Collin, You said:
“First, wasn’t the biggest reason for this drop the increase tax collected which was not planned for?”
No, what makes you say that.
Brian, Good point.
JV, Even worse, if you do the cyclically adjusted budget, the increase in 2008-09 is much less.
26. June 2015 at 15:44
Scott, here’s another one of those fun scatter diagrams with overlying regressions that we’ve all come to know and love of late, but with a slightly different subject:
https://twitter.com/COdendahl/status/614161821356937216
No report on the R-squared or p-value there, but it wouldn’t surprise me (from the looks of it) if the former is big and the latter is small.
Any comment?
26. June 2015 at 15:56
Ok as you asked for Keynesians to explain I’ll give it a go. From my perspective I don’t follow Krugman here who you are chiefly thinking of in this post when you say Keynesian.
I usually agree with him but not here. Just as not all libertarians agree sometimes even Keynesians can disagree! I think Simon Wren-Lewis did the better job of explaining 2013. For me it depends on what you expected to happen. I think the cut of $500 billion was not a good policy-though half of it was in defense which makes some Keynesian/liberal types conflicted. Yes, that would still hurt growth but maybe it’s better for spending to be redirected.
However, what do you have to see to prove that 2013 austerity was a harmful policy? Even though growth increased, it was supposed to have anyway and I think would have been even better had there not been the cuts. It’s the counterfactual problem. To me you can plausibly argue that even if growth accelerated in 2013 it would have done even more so without austerity.
On the other hand while you are counting the end of the Bush tax cuts as part of the austerity most Keynesians were happy about that and didn’t consider the top rate going from 35% to 39.6% as having much of a drag on growth-as the rich spend less of their income on consumption.
26. June 2015 at 15:58
I do think that to say there was no recession in 2013 or growth didn’t fall off a cliff is too low a bar to say that austerity was a harmful policy. The standard is what it would have been had there been no austerity.
26. June 2015 at 17:49
Hi Scott,
It appears that most of that “deficit reduction” is due to dividends from Fannie Mae and Freddie Mac …
http://informationtransfereconomics.blogspot.com/2015/06/always-look-at-data-keynesian-economics.html
The story is completely consistent with the Keynesian view.
26. June 2015 at 17:54
@Mike Sax: Sure, the counterfactual is what matters. But all that was up for discussion in late 2012. Recall the warning letter from 350 Keynesians? There were plenty of predictions back then about what economic growth might look like over the next year, both with and without the fiscal cliff. And there was overwhelming consensus (from the pro-fiscal crowd) that, if the fiscal cliff were avoided, then the slow, limping economic growth would continue, and 2013 would look a lot like 2012. But if the fiscal cliff happened, then it would spiral into a double-dip recession.
The result? The fiscal cliff happened, but the economy in 2013 was much like 2012 (even better, actually!) anyway.
Sure, in hindsight, you can always imagine that “things might have been even better!” That would be more credible, if you could demonstrate a track record of accurately forecasting (even conditionally) future growth ahead of time. Otherwise, it’s just an excuse for never having to change your preferred priors.
26. June 2015 at 20:24
Don I don’t see what how 2013 changes my priors. If only people who personally have a track record forecasting future growth ahead of time can have this discussion then few of us should even have this discussion.
As for this letter from 350 Keynesians there is nothing they said in that letter I now disagree with. I mean what in this paragraph has been proven wrong?
“We need jobs first. With recovery, deficit reduction will come of its own accord thanks to increased revenues in an improving economy. That was the case in the three decades after World War II “” when the debt to GDP ratio declined from over 120 percent of GDP in 1945 to under 30 percent by 1978.”
27. June 2015 at 08:31
@Mike Sax: It’s this claim that is implausible: “Even though growth increased, it was supposed to have anyway and I think would have been even better had there not been the cuts.”
You need to take yourself back to late 2012, assume the cliff is avoided, and make the strong prediction that growth is supposed to pick up sharply. Sure, some people did that … just as many people (including the White House and the Fed) predicted growth to pick up strongly in 2009, 2010, 2011, and 2012. They were obviously wrong each time.
You need more than a prediction (sans cliff) of strong 2013 growth. You need a plausible model that explains why growth was expected to kick off strongly in that year, but not in the previous four.
“I don’t see how 2013 changes my priors.” Is there any evidence that would? You obviously have a theory that additional fiscal stimulus raises economic growth, and fiscal cuts reduce growth. Can you even imagine any historical economic data you could observe, that might cause you to doubt your priors?
27. June 2015 at 08:36
@Mike Sax: “there is nothing they said in that letter I now disagree with”
Surely it didn’t escape your notice that they didn’t even mention monetary policy, or the possibility of monetary offset. You’re not even a little troubled by that omission, by their assumption that any fiscal changes translate directly into aggregate demand changes?
How about this section: “automatic “sequestration” spending cuts everyone agrees should be stopped to prevent a double-dip recession” The spending cuts happened, but the double-dip recession didn’t. This failed prediction doesn’t bother you in the least?
27. June 2015 at 09:20
Tom, I suppose you’d file this under “everything’s endogenous.” Those countries running big primary surpluses are those forced to do so by massive interest rate costs.
Mike Sax, You said:
“I think the cut of $500 billion was not a good policy-though half of it was in defense which makes some Keynesian/liberal types conflicted.”
This is not even close to being accurate. Not even close.
You said:
“On the other hand while you are counting the end of the Bush tax cuts as part of the austerity most Keynesians were happy about that and didn’t consider the top rate going from 35% to 39.6% as having much of a drag on growth-as the rich spend less of their income on consumption.”
This is not accurate, the top rate rose to 43.4%.
You said:
“I do think that to say there was no recession in 2013 or growth didn’t fall off a cliff is too low a bar to say that austerity was a harmful policy.”
I agree, but of course there’s much more to it than that, as you must surely know. Growth increased.
Jason, Interesting. Then I presume you disagree with Keynesians like Matt Yglesias who call those payments a contractionary “disaster”
Here’s Matt:
“The only problem is that this gusher of federal revenue is actually an economic disaster.
In normal times, government coffers filled with dividends would be good because they could be put to some use. The government could spend that money on building Hyperloops or repairing schools or vaccinating children. Alternatively, the government could do the exact same things it was doing before, but reduce taxes and put more money in working peoples’ hands. But that would require a functioning political system. Today’s gridlocked Congress isn’t doing anything with the money.
Still, under ordinary circumstances the reduced government borrowing that results from a dividend windfall could be useful. A smaller deficit often allows the Federal Reserve to run lower interest rates without sparking inflation. That makes it easier for people to buy houses or for firms to invest in new production. Today, though, the Fed’s preferred measure of inflation is running at its second-lowest level on record, even though short-term interest rates have been at zero for years now.
So the Treasury is earning tons of Fannie/Freddie money. But the profits aren’t letting us spend more, they aren’t letting us tax less, and they aren’t freeing up private investment capital either. They’re doing nothing. It’s as if the money were sitting around as cash in a storage locker somewhere.
What’s more, the money is very likely to keep piling up for quite some time. Essentially everyone in Congress agrees that the current situation, in which Fannie and Freddie are government-owned and dominate the mortgage market, should end as soon as possible. But they disagree about what, specifically, should happen next. Back on Aug. 6, the White House tried to put housing finance reform on the agenda with a speech endorsing legislation by Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., that largely tries to restore the pre-crisis status quo while drastically reducing the odds that the federal government will have to step in with bailout money in the future. But in the House of Representatives, Financial Services Committee Chairman Jeb Hensarling, R-Texas, steered a much more radical bill through committee that would eliminate Fannie and Freddie and replace them with nothing at all, leaving the mortgage market without the government backing it’s enjoyed since the Great Depression.
This is a fundamental clash of visions that’s hard to compromise away. What’s more, even though everyone says they want to end government ownership of the GSEs, there’s no particular deadline for getting it done. That means the issue is likely to stay on the back burner than get resolved.
Under the circumstances, it’s worth wondering if there isn’t something more economically constructive we can do with Fannie and Freddie while waiting for Congress to figure out the long-term picture.
Rather than paying dividends to the Treasury, the GSEs should pay dividends to the American people””writing checks to you and me. That way, conservatives can stop grousing that the reverse bailout is an Obama plot to make the deficit look small. More importantly, the profits can recirculate through the economy rather than sitting inert in the vault. People with more cash in their pockets will buy more goods and services.”
I can’t comment on the specific numbers, other than to make a few observations:
1. The fact that spending was flat doesn’t mean there weren’t cuts. Spending tends to trend up over times, so if spending was flat then it was falling as a share of GDP.
Mike, You said:
“As for this letter from 350 Keynesians there is nothing they said in that letter I now disagree with.”
Nothing at all? So facts don’t matter you you? The fact that growth increased in 2013 doesn’t matter to you?
27. June 2015 at 10:10
Hi Scott,
That is an interesting interpretation — viewing the government receiving dividends from holding Fannie Mae stock as an effectively confiscatory tax rate on a (very) particular asset. But we don’t count the revenue from TARP as contractionary austerity (on the Fed’s balance sheet rather than “the government’s”).
Basically, no one was holding the Fannie and Freddie stock for years before these dividends paid out. Like the banks and insurance companies, they were worthless in the immediate aftermath of the financial crisis.
It is therefore equivalent to the US government founding a company that turned out to be wildly successful with 300 billion in profits in one year. The money came “from nowhere”; it was created value — a 20 dollar bill on the sidewalk. It was only there because people panicked in the financial crisis.
Before Google, the billions it could have been worth weren’t contractionary — they didn’t exist.
It’s true it could have been put to better use (as Matt says, paid out to the people), but it isn’t contractionary in the sense of taking money from individuals and businesses. They were windfall profits from some company everyone had left for dead.
So yes, to make a long story short (too late), I’d disagree with Matt’s take.
27. June 2015 at 11:14
Jason Smith:
Interesting “interpretation”? Actually, Summer’s “interpretation” here is textbook Keynesianism.
You’re suggesting that more money acquired by the government is contractionary if it is mandatory (taxation), whereas it is not contractionary if it is voluntary (paying dividends), when nowhere in Keynes’ writings did he distinguish between voluntary and involuntary sourced demand.
Moreover, the dividends cannot be viewed as equivalent to money coming from nowhere, because in all cases money comes from somewhere, either from someone’s possession or the government’s printing press.
Before Google, the billions it would eventually become worth did exist, in part. When there was a lower supply of money that was used, again in part, on buying shares of equity in various companies, some of that would eventually be spent on Google shares. Then as more money was printed, and as more money was spent on stocks in general, with some stocks falling in price, Google then arrived on the scene and money that used to go to buying shares of other companies, plus new money from the printing press, went to buying Google shares.
Money that goes from the market to the government, if not treated as contractionary ceteris paribus, that is, if sometimes money going to the government is contractionary ceteris paribus (such as taxation) while other times it is not treated as contractionary ceteris paribus (such as dividends) means that your understanding of Keynesian theory distinguishes demand into two components, voluntary and involuntary, and hence invokes a value judgment about different demands as such.
In that case, your understanding of Keynesianism would lead you to say that in Keynesian theory, money spent voluntarily is more stimulative than money spent from involuntary transfer mechanisms such as taxation or the printing press. If that is the case, then any existing taxation or inflation, which makes voluntarily spending on those samsame things an impossibility, makes optimal economic stimulus an impossibility.
27. June 2015 at 13:52
What also can get lost is that there are other reasons you may have supported or opposed the sequester rather than the what it means for the fiscal stance.
For instance a Keynesian-as many Keynesians are also liberals-might have been torn-in fact many were torn-over the military cuts. They thought it would have an averse effect on the economy but they also believed that military cuts were a positive social thing.
Ideally they would have preferred to see it done in a less blunt and sudden way.
Similarly some Republican fiscal hawks still opposed the military cuts even if they would subtract from the deficit.
That’s why I don’t see how this debate is going to make a Keynesian suddenly say they shouldn’t have opposed the sequester. Even if you could convince him of monetary offset he may have other reasons to oppose it.
27. June 2015 at 18:51
Reading this thread exposes that economics is a hopeless exercise in chaos. Why not concede that economics is nonlinear and cannot be predicted?
28. June 2015 at 06:39
Jason, You may be right or Matt may be right. The entire Keynesian model seems insane to me, so one interpretation is just as good as another.
Here’s another question. All that GSE money had to come from somewhere, right? So the consumers paying money to the GSEs were indirectly paying money to the Treasury. If during a given year they pay $111 billion more, does that matter? Again, I don’t understand the logic of the Keynesian model, so I can’t answer that. What if that money comes from houses foreclosed on?
Ray, Economics is nonlinear? That’s a good one.
28. June 2015 at 11:16
Scott, Jason has another post on the subject if you’re interested.