Shlaes begins:
Every crisis has its heroes. For months now we've all been hearing about Walter Bagehot, whose 19th-century injunction to lend ``freely'' in a panic was cited by the Federal Reserve in its bailouts.
Who was this Bagehot character, anyway? Editor of some obscure commie-pinko rag called The Economist back in the 1860s and 70s. Who needs him?
Now another Englishman, John Maynard Keynes, has been pulled on the stage. Keynes taught that spending, especially spending by consumers, is the way out of a slowdown.
Um, well, not exactly. Which is to say, this sentence alone marks Shlaes as an economic illiterate whom it is downright dangerous to listen to. Quite the contrary of Shlaes claims, Keynes taught that government had to step in and spend when consumers did not. That spending could, of course, go through consumers, or through businesses, or both.
From last summer's small stimulus checks to the infrastructure projects under consideration by President-elect Barack Obama and congressional Democrats, almost everything the government has done or wants to do is justified by Keynes.
Only in the most general sense, in the same way one might say that it was justified by arithmetic. Keynes provides a general background, but there are plenty of other factors intruding as well, which is why stimulus checks were used, instead of more reliable methods, such as extended unemployment benefits or increased food stamp benefits, as we'll see below.
That's problematic. For Keynesian solutions often fail to deliver good or even acceptable results.
The limits start showing up with the tiniest of stimuli, those government checks Americans received in the mail last spring. The idea was that having the cash would cheer up consumers so that they would start shopping again, helping retailers. That in turn would revive wholesalers, shippers, suppliers -- on up the production line.
Well, yes, but this was clearly seen as highly uncertain at the time, due to the fact that consumers were mired in debt, and none too certain about the future. As I wrote at the time, in "Bipartisanship Vs. Reality: The Stimulus Package", the most reliably effective means of stimulating the economy were being sacrificed on the alter of bipartisanship:
The two most significant items that the Democrats caved on (food stamps and unemployment insurance) were the only items that non-partisan Congressional Budget Office (CBO) found that would be cost-effective, fast-acting, and certain to produce the intended result, as can be seen from the following chart, adapted from a January 22 presentation by CBO Director Peter R. Orszag:
| Policy | Cost-
Effectiveness | Time-Lag | Uncertainty | | Individual Tax Proposals | | Lump-Sum Rebate | Large | Medium | Large | | Temporary Tax Reductions | | Withholding Holiday for the Employee Payroll Tax | Large | Medium | Large | | Across-the-Board Tax Rate Cut | Small | Short | Small | | Deferring or Eliminating Scheduled Tax Increases | | Extending the AMT Patch | Medium | Long | Medium | | Deferring or Eliminating Tax Rate Increases Under EGTRRA or JGTRRA | Small | Long | Small | | Business Tax Proposals | | Cut in Corporate Tax Rates | Small | Long | Small | | Incentives for New Investment | Medium | Medium | Large | | Extending Operating Loss and Carryback Provisions | Small | Medium | Large | | Spending Proposals | | Direct Transfer Payments to Households | | Extending or Expanding Unemployment Benefits | Large | Short | Small | | Temporarily Increasing Food Stamp Benefits | Large | Short | Small | | Providing General Aid to State and Local Governments | Medium | Medium | Large | | Investing in Public Works Projects | Small | Long | Small |
But, of course, who needs reality?
Who needs reality? Certainly not Shlaes. As the CBO chart clearly shows, the tax rebates could have a large impact, but the uncertainty involved was high.
The chart above is truncated. Left off are the specific notes on each alternative. Regarding rebates, the chart in Orszag's presentation said:
A rebate is generally likely to be more effective the more it is focused on people who are likely to spend it. A rebate whose size increases for people with larger tax liabilities is likely to be less effective than a uniform refundable one. Experience is mixed with respect to effectiveness, introducing some uncertainty about the rebate's effect. Processing and mailing the rebate checks would take some time.
Whereas, regarding "Expanding Unemployment Benefits", the note read:
These benefits are regularly extended in recessions, and most of any additional benefits are likely to be spent quickly.
And regarding Temporarily Increasing Food Stamp Benefits, the note read:
Additional benefits are likely to be spent rapidly by recipients, who tend to be experiencing periods of economic difficulty.
In fact, the report contained quite a few comments about the questionable effectiveness of rebates, from the generic to the specific, such as:
The most effective types of fiscal stimulus (delivered either through tax cuts or increased spending on transfer payments) are those that direct money to people who are most likely to quickly spend the bulk of any additional funds provided to them.
The magnitude of the multiplier largely depends on how much of the additional increment to their income households spend. The higher that proportion, the more powerful the ultimate boost to demand. If the additional income put into consumers' wallets through stimulative policies is saved rather than spent, it will generate little extra demand and bring few resources into production. In a period of high uncertainty, when households may be seeking to retrench, fiscal stimulus may have a more modest effect because households are reluctant to spend.
Most studies of purely temporary, one-time changes in taxes [i.e. a rebate] have suggested that they have only a moderate effect on household consumption. Theory predicts that households not facing liquidity constraints will not alter consumption very much in response to a temporary change in income because it has a relatively small effect on lifetime wealth. For example, studies of the 1975 rebate (and earlier tax changes) suggested that only 12 percent to 24 percent of the rebate was consumed in the quarter that it was received.
In short, there was ample warning from the CBO, operating within a broadly Keyensian perspective (government acting to stimulate demand directly or indirectly) that the rebate proposal would have quite limited effectiveness. If a Keyensian critique was ignored in crafting the overall stimulus package, then the failure of the package can hardly show that Keyensianism itself failed. This is like using a math error to reject mathematics itself.
Shlaes continues:
But that stimulus failed, as the University of Michigan's Joel Slemrod and Matthew Shapiro noted. Interviews with consumers showed that only a fifth said they would spend their cash.
Savings rates tracked by the Bureau of Economic Analysis seemed to confirm that, with personal savings rates rising about the time the checks were mailed. Slemrod and Shapiro weren't surprised. They have spent much of their careers documenting failed stimulus plans. Their study of the effects of the 2001 Bush stimulus was so damning you might think that Washington would never repeat it. But Washington did.
Shlaes actually has things backwards here. Orszag's discussion of stimulus options cites the 2001 stimulus as one that appears to buck the trend of rebates generally being ineffective. He cited the Slemrod/Shapiro study, following two others showing a more positive impact, and said,
However, because that study did not include quantitative estimates of the impact on consumption, it is difficult to compare it with the two studies mentioned above.
Unlike the "damning" study Shlaes refers to, the two other reports Orszag referred to provided more solid, data-based quantitative estimates of the rebate's impact:
One widely cited study relied on quarterly data from the Consumer Expenditure Survey to provide estimates of the average propensity to consume the 2001 tax rebate.16 The study's authors estimated that households spent between 20 percent and 40 percent of their rebate amount in the quarter in which the rebate was received and about two-thirds of the rebate cumulatively by the end of the subsequent quarter. According to the study, the rebate increased total consumption by about 0.8 percent in the quarter that the rebates were received and by about 0.6 percent in the subsequent quarter. The authors also found strong evidence that households that were young, had low income, or held few liquid assets consumed a substantially larger fraction of the rebate than did households that were older, had high income, or had large holdings of liquid assets.
Researchers using credit card data to examine the effects of the 2001 rebate on consumption found a similar impact.17 Households' credit card debt immediately dropped upon receipt of the 2001 rebate. However, subsequent credit card spending rose. The researchers have access to data on the primary credit card for only a subset of cardholders, but among those households, spending increased by $200, or about 40 percent of the rebate on average. The study also found that consumption rose the most for consumers who were likely to be credit constrained. By contrast, unconstrained consumers responded to the rebate by paying down their debt (which increases saving).
In short, Shlaes simply ignores hard data that paints a nuanced picture in favor of soft (interview-based) data that confirms a pre-conceived ideological conclusion.
Shlaes again:
Long View
One reason consumers don't want to spend is that they don't react instantaneously, as Keynes posited they would. They follow, rather, the theory of an economist oft-presented as the anti-hero of the moment, Milton Friedman. Friedman's permanent- income hypothesis said that consumers consider their entire future, and not just their mood, when they shop. If expectations of lifetime earnings drop, then so will spending. That too tracks reality. Many of us are beginning to wonder if we will ever get back the price we paid for our houses.
More ideological balderdash. As already noted, neither Keynes nor modern-day policymakers and advisors, such as Orszag, depend on a single modality for stimulating the economy. What's more, Orszag's discussion contains considerable reference to permanent income effects. I'll just cite one example, because it further demolishes Shlaes use of the 2001 rebate example, but from a different direction:
The experience of the 2001 tax rebate appears to differ from the findings of these earlier studies, although the 2001 rebates did not represent a one-time reduction in taxes, and therefore the experience with them may not be fully applicable to a truly temporary rebate. The 2001 rebate stemmed from provisions of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, which reduced the lowest tax bracket from 15 percent to 10 percent, among other things. Although EGTRRA was signed into law in June 2001, the change in the lowest tax rate was applied retroactively to income that was earned from the beginning of 2001. (The rebate amount was based on each tax filer's 2000 return.) The rebate was essentially an advance credit for the reduction of taxes in 2001 and represented an early lump-sum payment of amounts that otherwise would have been accounted for through reduced withholding in 2001 or increased refunds in 2002.
That's right, folks! The 2001 rebate was actually a down-payment on what Shlaes says is the real key to increased spending! So much confusion, so little time.
But what about the larger stimulus plan, the kind President-elect Obama is considering? The idea is to revive Franklin D. Roosevelt's New Deal and create jobs by building new bridges or roads. Obama has also spoken of a kind of corps for the young, which, you get the sense, might be involved in some of these projects. That comes out of the New Deal and FDR's Civilian Conservation Corps.
Keynesians would say such moves will bring the economy to life, creating jobs and replacing crumbling infrastructure.
They would also say-as Keynes himself did-that Roosevelt's spending was not enough, and his cut-backs in 1937 were disastrously premature. Much more government spending was needed, and WWII finally delivered it.
Point-to-Point
Others would argue that the productivity gains to be had from an infrastructure program also are significant. That's the view of scholar Alexander Field, who studied the New Deal and found that the private sector benefited enormously from its construction projects. After all, when the government supplies a bridge from Point A and Point B, the private trucking company can deliver goods between A and B faster. The project may be public, but its ``spillover'' yields profits too.
Yet more stunning proof that Shlaes is an economic illiterate. "Spillover" effects are another word for externalities, incidental effects unrelated to the purpose of an economic activity. But when you build a bridge, the whole purpose of building it is so that folks can use it-including private trucking companies. They are not "spillover." They are part of the reason for building the bridge in the first place.
The best evidence for the infrastructure spending case comes not from a Democrat but from a Republican: Eisenhower's National Highway System. The rebuttal there is that emphasis on government in the 1950s made the decade a dull one that stifled innovation.
Just like all that stifling spending during WWII, which laid the foundation for the computer, electronics and communication explosion that just kept building from the 1940s onward. Or the stifling spending of NASA. Why, if it weren't for them we'd all vacationing on Risa by now! Oh, wait! The Federation is a government, right? Well, nevermind!
And you also have to ask: What is lost when Washington puts resources into such road projects?
You have to ask: What is lost when newspapers put resources into publishing such drivel? Does Shlaes have any idea what America would be like without interstate highways? There's plenty to criticize about them, to be sure. Nothing that huge is without its problems. But Shlaes is actually arguing here that Obama shouldn't get carried away or he might just build something as impressive as the interstate highway system, and that would just be terrible!
Well, we always knew Eisenhower was a Commie dupe. The John Birch Society told us so!
One problem is that a stimulus project and an earmark are dangerously similar. Sometimes the government will waste its resources on bridges that truckers won't use -- the new Bridges to Nowhere.
Yes, yes. If you let government do good and sensible things, then that means it can be hijacked by Republican crooks to do terrible, stupid things. You can either shut down the government or get rid of the crooks. I wonder which one makes more sense?
Gloss Job
But the most telling fact about the new rush to spend is that its advocates have insisted on invoking the New Deal.
Um, maybe because we're facing the worst financial crisis since the Great Depression, and the New Deal was how we started growing our way back out of that horrendous hole?
They tend to gloss over the period when the phrase, ``We are all Keynesians now,'' was actually first uttered: the mid-1960s. (Uttered by Friedman, in fact, though he meant only that we all work in the terms of the Keynesian lexicon.)
Um, maybe because that period was nothing like our current situation? And like you said, the Friedman quote is utterly irrelevant to whatever point you're trying to make.
The Great Society of that period was the ultimate Keynesian experiment, and it didn't work very well.
No, and no. The Great Society wasn't trying to increase demand. The economy was doing just fine. The Great Society included a vast array of programs covering all sorts of things, but one of the most basic and far-reaching was Medicare, which managed to slash poverty among the elderly drastically in just a few years.
One example is VISTA, the domestic Peace Corps from that period. VISTA had mixed results and has been renamed and reshaped many times since. Its full name, ``Volunteers in Service to America,'' fits perfectly as a description of the youth programs the Obama camp has described.
And you mention VISTA why? VISTA was created to increase consumer demand how? (You're the one who insisted that Keynes was all about the consumers, remember?)
The leaders of the 1970s and 1980S -- Nixon, Ford, Carter, Reagan and Paul Volcker -- were left to live with the Great Society aftermath. The jobs that Keynes emphasized were AWOL: America became accustomed to high levels of unemployment.
So Shlaes is actually blaming the economic woes of the 70s and 80s on VISTA? And not OPEC? Look, I'm always one to question single-cause explanations. But given the choice between thinking that the end of cheap energy caused all our problems or a bunch of young idealists did, I'm going to have to go with the high fuel costs. Call it lack of imagination, if you will, but I can't even conceive of the drugs that Shlaes must be on, much less afford them.
Were they alive, both Bagehot and Keynes would defend themselves. Bagehot, for example, would say that he saw the central bank as the lender of last resort, not the lender of first resort.
And who, exactly, would he be talking to? Who exactly sees the central bank as the lender of first resort?
Keynes would note he operated in a gold-standard world, or tried to, not in our free-float-except-for-China arrangement.
What in God's name does the gold standard have to do with anything? Doubloons, anyone?
Besides, Keynes proposed flexible exchange rates as far back as his Tract on Monetary Reform in 1923, more than a decade before his General Theory.
The important thing to recognize is that the record of actions taken in economists' name is mixed. Try this sentence: We're not all Keynesians now.
Try this sentence: 20 to life.
If we're going with non-sequiturs, why mess around?
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