August 22, 2003

Surprise, Surprise...

From the Center on Budget and Policy Priorities:

$401 Billion vs $455 Billion: Good News, Bad News, Or No News?, 8/13/03: In early July, we issued a projection of future deficits.  Our analysis explained that official budget projections paint too rosy a picture because they omit costs that are likely or nearly certain to occur.  For example, CBO's March "baseline" projection reflected laws in place at that time.  CBO consequently assumed that the various tax breaks enacted in 2001, 2002, and 2003 would expire on schedule. 

Likewise, CBO omitted relief from the Alternative Minimum Tax after tax-year 2004 and did not include the likely enactment of a Medicare prescription drug benefit.  Our report concluded that if these and other likely costs occur, deficits over the ten-year period from 2004 through 2013 will total $4.1 trillion, will not fall below $325 billion in any year, and will reach $530 billion, or 3.0 percent of GDP, by 2013.

Other analysts, such as Goldman Sachs, the Concord Coalition, and the House Budget Committee minority staff, have published similar estimates.

Significantly, our $4.1 trillion ten-year projection included a deficit estimate of $403 billion for 2003 and $446 billion for 2004.  CBO's current estimate of $401 billion for 2003 is virtually identical to -- and thus reinforces -- the projections we issued in early July.  Similarly, on June 17, Goldman Sachs projected a $425 billion deficit for 2003 and a $4.5 trillion deficit over the ten-year period 2004-2013, while the Concord Coalition earlier projected a deficit of about $420 billion for 2003 and $4.0 trillion over the decade. These projections, as well, indicate that a deficit below $455 billion in 2003 should not be interpreted as good news for the future...

In short, it now appears that OMB%u2019s July figures both overstate the short-term deficit and seriously understate the long-term deficit.  The OMB estimates understate the long-term deficits because they omit some costs that are very likely or nearly certain to occur in years after 2004. Posted by DeLong at August 22, 2003 08:19 AM | TrackBack


1) We should all, I believe --- even Democrats like myself --- be more cautious about the long-term trend of federal deficits. Similar catastrophic warnings were issued throughout the 1980s after the Reagan tax-cuts, and eventually --- contrary to conventional political wisdom --- Congress was willing to twice increase taxes in the 1990s, first in the Bush Sr. administration and then in the Clinton era.

2) Whether those tax rises made much difference in the subsequent bursting growth of GDP and labor productivity after 1993-1994 --- along with the totally unpredictable decline in unemployment to around 4.0% without new inflationary pressures --- isn't clear. What we do know is that faster GDP growth in the 1990s not only steadily reduced the federal deficit from an all-time high as a % of GDP in 1992, but eventually changed the deficit into a surplus.

3) There were always some liberal economists --- especially Robert Eisner, the former head of the AEA --- who supported the Reagan deficits and warned the critics that they were unduly pessimistic about the predicted bad effects of those deficits. He was convinced above all --- a lonely voice even in liberal circles --- that the estimated level of natural unemployment at around 6.0%, an estimate clung to throughout the mid- and late-1990s by most of the economics profession, was way overdone and bluntly wrong.

Eisner proved right. Even if there was some crowding out of net business investment in the 1980s as a result of the fiscal deficits, it didn't happen as much as the critics had predicted. Even if the crowding out in loanable funds markets was largely blunted by a huge inflow of foreign capital, the resulting trade deficits began to reverse themselves after 1985 --- US exports essentially doubled in the next 5 to 6 years --- and we now know that there is no direct causal link between the size and even direction of federal deficits on one side and trade deficits on the other.

Tersely put, the US current account mounted rapidly in the early and mid-1980s with rapidly growing fiscal deficits, then began to reverse itself noticeably even with those fiscal deficits continuing to soar. More unpredictably too, the current account deficits surged to new heights in the late 1990s despite the federal deficit turning into surplus for a few years.

4) Meanwhile, as Eisner and some others noted, whatever the supply side hype surrounding the Reagan tax cuts and deficits at the time, the huge jump in US GDP growth that followed --- together with the leap in the US current account --- most likely saved the global economy from a new Depression: call it, if you prefer, a sustained sharp recession and slump. Estimates in the mid-1980s found that well over half the revived growth of Germany and Japan --- which of course then had beneficial spillovers to the EU and Pacific Asia --- could be traced back to their export-led growth into the booming US economy.

5)So where are we now?

a) Similar pessimism surrounds the long-term projections of soaring US federal deficits way into the future. That pessimism seems excessive and overdone. Job-wise, we are back in the early 1980s as far as excess capacity in the economy goes, and we need to find ways to accelerate national spending in order to reduce the output gap between actual GDP growth and the new, much higher potential output.

b) Beliefs that crowding out in loanable funds markets will be caused by US fiscal deficits seems overdone too. There may be some, but it hasn't occurred in the standard textbook way from the early 1980s on. Whether that's due to an influx of foreign capital, or whether the Ricardo-Barro theory is at work here, or whether there's just no clear correlation, are matters that just are unresolved.

c) Beliefs that the inflow of foreign capital as something bad to compensate for the insufficiency of US national savings --- given our investment levels --- seem overdone too. What exactly is wrong with incurring liabilities to foreigners if they are voluntarily willing to leave their capital in the US, rather than sell off dollars and have the dollar decline steadily in currency markets. As long as the rest of the world seems to prefer export-led growth, at least one major country, the US, has to run continued current account deficits to accommodate them.

The trick is to ensure that the added national savings that follow from the capital inflows --- the counterpart of our current account deficits --- are largely used for sustaining higher levels than otherwise of national investment. That might not have been the case in the 1980s (though recent new estimates of national investment and savings have adjusted the decline in net investment downward somewhat); but it definitely was not the case in the 1990s. And to repeat, there is no observable correlation between federal deficits and trade deficits.

These matters, I add, are explained in a mini-series on the US trade deficit just published on the buggy professor web site:

d) More generally --- here I speak as an outsider, a professor at UC Santa Barbara in political science, not an economist --- it seems there are lots of cocksure proclamations from various sides in the financial and economics professions about macroeconomics and policymaking that haven't a solid foundation.

-- Does crowding out occur? What are the statistical studies that convincingly show this?

-- Is the Barro update of Ricardo sound? Lots of the studies, here and abroad, show some rise in private savings as government deficits rise, but lots don't.

-- Is net national investment the best way to measure national investment and hence savings? Why not gross investment, especially since the new machines used these days as replacement capital for older machines --- say, computers and their software --- seem to embody more recent technologies and hence possibly to raise the level of productivity more than otherwise?

And, for that matter, if we now include in net national investment new roads built by the government at any level, why isn't a private household that buys a vehicle for use on those roads to travel to work regarded as investment too, rather than consumption? It is certainly a durable good, and it is indispensable to getting work done on the job as part of the larger productive process.

-- How much, for that matter, does business investment depend on the levels of real interest rates compared to all sorts of other influences, such as optimism about the growth of the economy and above all future sales prospects in their industries?

-- Why do numerous economists keep predicting some sort of catastrophe from large persistent current account deficits? These doom-doom predictions have been going on since the mid-1980s, and yet doom never occurs. Maybe the entire way of relating national income stats to trade stats needs to be thought through anew, especially since national income accounting was pioneered at a time, decades ago, with largely a closed economy in mind. Only in the 1950s was there, if I remember correctly, efforts to bring in the trade side (exports and imports) by James Mead and others. Might it not be time to see what all this means in an era of increased globalization and multinational activity and all sorts of investment flows across borders that the original and updated work of the 1930s - 1960s never came fully to terms with?

-- Is there any evidence that the Federal Reserve will lose autonomous control over monetary policy in order, as the doom-doom critics also say, to keep up the confidence of foreign investors? If so, where is it above and beyond the concern of Greenspan and his fellow Fed members to keep the US economy growing dynamically and offsetting inflationary pressures?

-- What exactly causes foreigners to invest here anyway? You, DeLong, noted some interesting political motives in such inflows not long ago (I replied at length three times, I believe, in that forum), and there may be motives that haven't been fathomed as yet. Certainly, arguments that it's only the real return on interest rates in the bond markets --- compared to the returns abroad, taking into account the trends in the price of the dollar in currency markets at present and in the future --- seem inadequate. Standard views also look at differential inflationary rates, but they have all been done considerably, if not disappeared as a problem, in the EU, the US, and other industrial countries (and even most of Latin America) --- never mind Japan with its steady price deflation of around 1.0% a year since 1997 or 1998. (China too, despite hard-to-believe GDP growth reports, suffers from price deflation as well.)

Or is it the political stability of the US, plus the belief around the world the US is a more dynamic economy for investment, plus the determination of foreign political leaders to enjoy export-led growth (hence if need be to buy dollars in currency markets in order to keep the export-led growth going at home), plus the huge range and depth of US financial investments and our general indifference to foreign ownership, plus . . . well, what exactly?

-- And, to come back to the jump-off point of these comments, why --- given our experience with the Reagan deficits that continued through the Bush Sr. years --- are so many people, including economists, convinced that they augur bad fortune or even doom or catastrophe for the future health of our economy?

I could go on, but the point, I trust, is made. Macroeconomics remains a badly divided discipline, with all sorts of claims advanced by all sides --- Keynesians, New Keynesians, supply-siders, Barro-Ricardians, monetarists, and real business cycle theorists, never mind the problems of explaining balance of payments trends on current and capital accounts and the causal connections --- that seem, as a general thing, to exceed any solid scientific basis. For what it’s worth, the buggy professor site has dealt with all this at length in an article published August 8th, 2003:

-- Michael Gordon

Posted by: michael gordon on August 22, 2003 10:10 AM


Wow. Go Michael G. A question. Isn't a set of budget projecting rules enshrined somewhere requiring that federal budget projections ignore changes that might happen, sticking to laws already in place, taking at face value whatever is written in those laws and ignoring things (like extension of tax cuts due for sunsetting) that are not written into the law, even if some changes are a sure thing? I appreciate that the OMB could, and probably should make additional estimates which include a variety of more or less foreseeable changes. Still, if OMB is required to ignore the things it is ignoring and assume the things it is assuming, shouldn't the folks at the Center for Budgetand Policy Priorites point that out? Or do the rules I am thinking about not apply to the situation at hand?

Posted by: K Harris on August 22, 2003 10:38 AM


"We should all, I believe --- even Democrats like myself --- be more cautious about the long-term trend of federal deficits."

Phooey. Try reading Paul Krugman and for analyses of precisely how bad fiscal policy has been in this Administration. This Administration has created a very serious deficit problem that delights radicals who wish to use it as an excuse to slice Social Security, Medicare, and Medicaid to ribbons.

Posted by: lise on August 22, 2003 11:04 AM


michael gordon wrote:

> 1) We should all, I believe --- even Democrats like myself
> --- be more cautious about the long-term trend of
> federal deficits. Similar catastrophic warnings were
> issued throughout the 1980s after the Reagan tax-cuts,
> and eventually --- contrary to conventional political
> wisdom --- Congress was willing to twice increase taxes
> in the 1990s, first in the Bush Sr. administration and then
> in the Clinton era.

But for extra credit, write a two-page essay detailing the contributions of the Bush tax increase to his electoral fate in 1992 and the extent to which the 1993 budget deal led to a Republican majority in Congress for the first time in 40 years. In other words, principled moves like this have had (or are perceived to have had) slaughterously negative political implications. As for the wisdom of campaigning on such issues, ask Walter Mondale about how his 1984 run went.

(In a fair and balanced account, you could point out that Perot did run in part on budget issues at least in 1992 and did better than many expected. But the 20% share of the vote he got was useless as far as winning the election goes, and it's not like Perot voters turned out big in 1994 for candidates who rammed the tax deal through the previous year.)

Posted by: Jonathan King on August 22, 2003 11:05 AM


"Eisner and some others noted, whatever the supply side hype surrounding the Reagan tax cuts and deficits at the time, the huge jump in US GDP growth that followed --- together with the leap in the US current account --- most likely saved the global economy from a new Depression...."

Please. This is mere supply-side all-side nonsense. What a hoot.

Posted by: anne on August 22, 2003 11:09 AM


Conan the Deceiver

The key moment in Arnold Schwarzenegger's Wednesday press conference came when the bodybuilder who would be governor brushed aside questions with the declaration, "The public doesn't care about figures." This was "fuzzy math" on steroids — Mr. Schwarzenegger was, in effect, asserting that his celebrity gives him the right to fake his way through the election. Will he be allowed to get away with it?

Reporters were trying to press Mr. Schwarzenegger for the specifics so obviously missing from his budget plans. But while he hasn't said much about what he proposes to do, the candidate has nonetheless already managed to say a number of things that his advisers must know are true lies.

Even Mr. Schwarzenegger's description of the state economy is pure fantasy. He claims that the state is bleeding jobs because of its "hostile environment" toward business, and that California residents groan under an oppressive tax burden: "From the time they get up in the morning and flush the toilet, they're taxed."

One look at the numbers tells you that his story is fiction. Since the mid-1990's California has added jobs considerably faster than the nation as a whole. And while the state has been hit hard by the technology slump, it has done no worse than other parts of the country. A recent study found that California's tech sector had actually weathered the slump better than its counterpart in Texas. Meanwhile, California isn't a high-tax state: through the 1990's, state and local taxes as a share of personal income more or less matched the national average, and with the recent plunge in revenue they're now probably below average....

Posted by: jd on August 22, 2003 11:28 AM


Michael Gordon's argument is strange - it is both detailed and lacking very important details at the same time.

For instance, after Reagan's "historic" first tax cut, the predictable happened - budget deficits soared as revenues fell. Those revenues were not offset by higher growth. So, the economic team was overhauled. And who did they bring in? You might know two of them:

Paul Krugman and Laurence Summers.

Yes, Paul Krugman worked for the Reagan Whitehouse economic team.

They proposed a series of tax-cut rollbacks, which Reagan, in a remarkable intellectual juggling act to prevent cognitive dissonance, said he wasn't raising taxes, merely closing loopholes. This partial restoration of fiscal sanity helped keep the country from going into a GWB-esque financial meltdown.

Yep, boys and girls, the famous Reagnan growth wasn't initiated by the supply-side free-lunch lunatics, but by that hated enemy of everything that is holy, the Keynesian Paul Krugman.

Of course, GWB will never fall for another Keynesian trick like that. He has safely moved the economic team outside of the White House. It was moved to the corner of 17 and H, next to the Starbucks – safely out of eye and ear-shot. Karl Rove has probably even put a call-block on their phone number and disconnected their internet.

GWB's economic policies may be worse than something concocted by a drunken chimpanzee.

Posted by: SZ - FairAndBalanced on August 22, 2003 01:00 PM


The buggy professor's comments about Reagan deficits are buggy. First of all, the surplus that Clinton ran was marginal and fueled by huge revenue inflow from stock market bubble profits. The budget suffers from including SS which is currently running a multibillion dollar surplus. If account correctly, leaving off social security trust fund (the money is already spent) then Clinton ran a surplus only one year and WBush never ran a surplus.

Reagan tripled the deficit from $1 trillion to almost $3 trillion. The interest payments on the national debt were greater than total deficit of the Clinton years. In the Clinton years, the middle class went without the promised tax cut, we did not get health care coverage and other safety net programs were stymied by lack of funds. Since 1995, the US treasury has been spending over $300 billion every year on interest payments. How much of the prescription drug coverage could be had for $300 billion per year? This is the Reagan legacy. Bushynomics is making it worse.

Let's go back to 1980. There was an oil crisis. Oil prices skyrocketed. In order to stop the US from transferring all its wealth to OPEC, interest rates were raised to double digit levels. Along about 1982, the fuel efficiency standards enacted under Ford and Carter started to kick in. The fuel consumption dropped by over 25%. This broke OPEC power and allowed interest rates to descend.

Reagan did not just cut taxes. Reagan cut taxes on the wealthy and then INCREASED payroll taxes by 50% on the working class. The Reagan tax cuts were such a mess that Bob Dole cobbled together some fee increases and other revenue enhancement to stop the bleeding. In 86, Congress increased capital gains taxes. In short, Reagan tax cuts did not have a great stimulatory effect on GDP. To assume the did is hogwash.

The CBPP analysis going back to 2000 has consistently shown that the Bush tax cuts were unaffordable and ignore the looming future problems of Medicare and SS obligations.

Reaganomics was a disaster all around. It is still hurting. Mr. Bush by borrowing over $550 billion this fiscal year and we still have over a month to go. That's right, the $400 billion debt includes the SS surplus that is already spent. The $400 billion does not include the billions borrowed from SS. The economic policies of this adminstration are indefensible. The Reagan deficits were indefensible. 50 years from now when the political baggage is lost and economists take an unbiased look at the late 20th century the same conclusion will be reached. Reaganomics and Bushinomics are bad policies.

Posted by: bakho on August 22, 2003 01:03 PM


1. “be more cautious about the long term trend of federal deficits” This is a stupid statement. The analysis is what will happen IF THE CURRENT POLICY DOES NOT CHANGE. Of course future administrations can clean up the mess. The analysis says what will happen if we do not change policy. Duh. The Democrats spent a lot of political capital cleaning up Reagan’s mess. Don’t expect them to clean up the Bush mess if it costs them the election.

2. “the totally unpredictable decline in unemployment to around 4%” This statement overlooks that the Fed targets and unemployment rate. When unemployment drops too much, the Fed raises the interest rates. When unemployment goes up, the Fed lowers the interest rates. President Clinton made a deal with AG that he would hold the line on spending and decrease deficit spending if AG would allow the unemployment rate to drop below 6%.

3. Eisner was correct about 6% unemployment being too high. Eisner did not say that it was better to have the debt than not have it. What do you mean there was not crowding out? A huge inflow in foreign capital investment means a huge outflow in domestic corporate profits. Duh. Who is arguing that foreign accounts deficits are linked to federal deficits anyway? They are more closely linked to the international price of oil which was high in the early 80s and lowered as fuel efficiency improved and oil use declined. When oil use returned to 1980 levels in the late 1990s the trade deficit increased. Go figure. Put that in your SUV and drive it.

4. What huge leap in GDP growth that followed the Reagan tax cuts? GDP always grows compared to a recession. Duh. The expansion under Reagan was no larger than similar expansions without deficit spending.

Posted by: bakho on August 22, 2003 03:17 PM


Interesting thread! From it, as a practicing non-economist, I glean that:

The Reagan deficits worked as a Keynesian stimulus versus the Reagan recession, combined with falling oil prices. The early deficits were addressed very quickly by some politicians who behaved in a statesmanlike manner by raising revenue, enough to satisfy the worries of those-- the gnomes-- who were going to arrange the funding to cover the deficits. A big part of the deal was piling up SS surpluses from payroll taxes and counting them against current spending.

I think deals like these were possible because the Cold War imposed discipline on politicians and forced them occasionally to do the statesmanlike thing-- at some cost to their careers, as pointed out, once the Cold War was gone. Plus, there was a hangover from the preceding generation (of Marshall, Eisenhower, et. al.) who were forced in their day to think about issues of fundamental social order and cohesion. Some of them were consulted during this maneuvering.

We have nothing like that today. Congress has reverted to its 19th-century nuttiness but now it's worse because the parties no longer have ties to functioning local machines that actually know what it takes to govern. On the contrary, they're in thrall to the White House in a way that the founders would have called corrupt.

The White House itself has been completely taken over by political advisors who have nearly zero contact with the real world except insofar as they believe perceptions can be managed. These advisors have no truck with people who have any substantive knowledge in policy areas. And they lie.

Suppose the estimates for '03 deficit are about $405B. As mentioned, the SS surplus has to be taken out of that. Iraq costs have to be added in because only some of them have been up to now. That's $2B a week plus something like $30B that hasn't been added in yet. I'm approaching $550B here as a more real number.

Is the tax code now structured to gain any percentage of GDP if there is significant GDP growth? I've seen little to indicate that, but rather hinting the opposite-- that tax revenue as a proportion of GDP is now set to fall as GDP grows.

And worse, if I understand the SS fudge correctly, when SS revenues go negative, the special bonds have to be redeemed out of current revenue.

This doesn't give me a lot of optimism. I don't see the same kind of political incentives this time around that were at work in the 80s. It seems instead that we are intent on testing the limits of a fiat currency regime.

Posted by: Altoid on August 23, 2003 09:46 AM


Nice surmise.

Remember, we are an older country than in 1980 or 1990. Social Security and Medicare obligations will grow rapidly as the boomers retire. This deficit promises to be more of a problem simply because the federal tax system has been turned either flat or regressive. We have not come to grips with the costs of Iraq. Well, we never came to grips with the costs of building a stable Afghanistan.

Posted by: anne on August 23, 2003 09:57 AM


The purpose of a baseline is to show what kind of federal budget balance will result from CURRENT LAW. Leave it up to others, like the CBPP or anyone else, to prognosticate about what might or might not happen politically (sunsets, new entitlements, etc.). I don't like this notion of painting a baseline budget projection as somehow being dishonest, when everyone ought to know exactly what a baseline is before even looking at the first number.

Posted by: Sean on August 23, 2003 10:58 PM


So, the point of budgets is to mask the effects so the damage is impossible to project. Ah. We have an awful budget mix, as anyone honest person can tell. But, this Administration is doing the best it can to assure there are no honest persons working for in government economics departments.

Posted by: anne on August 24, 2003 07:32 AM


I thank everyone for their comments, including those of Mr. Bakho, the Wizard-of-Duhz, who seems to think that an argument is advanced by insults and various forms of name-calling. Very briefly,

(1) Supply-Side Stuff

----- I. First Anne: She quotes a sentence of mine referring to "supply-side hype", disagrees with the observation iun that sentence, then thinks I'm guilty of . . . well, supply-side hoot:

Anne's statement:
"Eisner and some others noted, whatever the supply side hype surrounding the Reagan tax cuts and deficits at the time, the huge jump in US GDP growth that followed --- together with the leap in the US current account --- most likely saved the global economy from a new Depression...."

Please. This is mere supply-side all-side nonsense. What a hoot."

I'm not certain what sort of logic this is --- maybe the Wizard of Duhz can clarify it for us --- but it leaves the buggy prof puzzled.

Factually, it's not a hoot. The combined oil price surges of the 1973-74 period and 1979-80 had crippled world economic growth by 1981. Macroeconomic policy had also become erratic: the primary Keynesian policy-guide, the Phillips curve alleged stable tradeoff between less unemployment at the margin and more but predictable and stable inflation had broken down; and the Fed in this country and the European and Japanese central banks were all following very tight monetary policies even as unemployment kept rising and inflation too. (Japan was doing better on that latter score, but not much.) The term "sclerotic Europe" was even run on the cover of Time or Newsweek in 1983 as the US economy itself was recovering. Subsequent analysis showed that about 50-67% of the German and Japanese revival in GDP growth after the US revival in 1983 --- GDP was a bursting 7.3% real growth for the year --- could be traced to the recovery of the US economy, thanks to their huge export drives to us . . . with all the multiplier effects on their own GDP and that of their neighbors through the trade sector that followed.

---- II. SZ, on the other hand, believes the credit for the achievements --- and presumably problems --- of the Reagan era should go to Paul Krugman and Larry Summers.

(2) I did note that despite the supply-side hype of the time, net national investment did not itself rise as supply-siders had hoped. In fact, it was a tad below the average in past recoveries and over the business-cycle, and lower than in the 1990s . . . though how much of that had to do with replacement capital-investment in outmoded energy-systems --- replacing, say, old coal-driven generators with newer ones amounts to GROSS investment --- is something I can't say.

(3) An economy with big excess capacity vs. a full-employment economy.

--- I. Nobody in the forum seems to grasp the difference between what fiscal policy ought to be when an economy is seriously afflicted by noticeable excess-capacity --- the condition of the US economy in the early 1980s and again in the early years of this decade ---- as opposed to one operating at full employment (the natural rate, the NAIRU). [Whether the latter is even a sound guide for policymaking is itself questionable, as I hinted at in the questions raised about macroeconomic guides to policymaking. An important paper by Douglas Staiger, James Stock, and Mark Watson in 1997 found that with a confidence interval of 95%, a typical estimate can range over the past they studied from 5.1% to 7.7% (the year 1990). See]

--- II. Eisner's key point --- repeatedly made in the 1980s even as fellow liberals attacked him --- was that when an economy like the US is in serious job trouble marked by large excess capacity, massive federal deficit spending is needed. Far from that being an exotic view, though, it was standard Keynesianism of the old sort . . . vs. the New Keynesianism that, associated with Gregory Mankiw and most economists with liberal leanings draws on rational expectations and the need to look at the micro-basis of macroeconomics. Essentially, new Keynesians still regard the market economy as embodying some large market-failure(s) that can block effective short-term adaptability to various shocks --- endogenous and exogenous --- and hence in need of active macroeconomic policymaking that, though, should usually be rule-based.) For clarification of all this, see the buggy prof article, "Is Economics A Science? Can It Be?"

For the larger view of Eisner’s outlook on how to treat an economy with large room for job-creation and GDP growth, see the survey of Eisner’s policy recommendations of the 1980s in the light of what subsequently happened ever since by Benjamin Friedman, a well known liberal economist at Harvard:

(4) Mr. Bathko’s Hard-To-Fathom Comments

--- I Bathko seems to think that long-term economic growth in the US economy --- or any probably --- is dependent on macroeconomic policymaking, wholly a demand-side phenomenon. At least that’s what the puzzling references to Alan Greenspan and Bill Clinton seem to imply, as though jobs and investment and GDP growth over a long period --- say 8 years --- are determined on the demand side. Most of us think potential output --- the long-term growth trend --- is structured wholly on the supply side: inputs of investment capital, growth of the labor force, the quality of the labor force, inputs of fuel and raw materials, and technological progress. About the only half-way meaningful point Bathko seems to be driving at is that the Fed has the power to choke off a recovery if it tightens monetary policy too much --- deliberately or not.

--- II. Eisner, an old-fashioned Keynesian, is misinterpreted by Bathoko --- to the point where you’re left wondering whether the Wizard of Duhz isn’t pulling out observations from the depths of ignorance. As Friedman’s article noted, Eisner believed that the need for fiscal deficits was built into a capitalist economy like ours, given a tendency toward insufficient aggregate demand on the private size. He would have been surprised, Friedman observes, to have lived to experience the fast growth of the late 1990s with first declining central government deficits, then a surplus. (Eisner, I add, was also active in showing in the 1980s and early 1990s that national debt as it mounted was exaggerated in nominal terms. If inflation were rising 3% a year, then total national debt in real terms was declining. He also noted that you had to consider what was happening with fiscal trends in the states: most were in surplus in the 1980s, and hence that surplus had to be deducted from federal government deficits. He also all along argued --- a good liberal point that the Wizard of Duz might even agree with if he knew more --- that government spending wasn’t just consumption (as it was counted until the mid-1990s by the Bureau of Economic Analysis), but included highly desirable investment. We also know, thanks to the work of D.A. Aschauer in the late 1980s and early 1990s that government investment can be as effective and cost-efficient in generating long-term GDP growth --- and possibly raising its trend-rate --- as private investment, and at times even more efficient here. How much, though --- as with so much macroeconomic policy guidance --- is uncertain. The best overall comparative study of the subject across OECD countries --- carried out by a Dutch team in 1996 --- seemed to find at most a modest contribution to economic growth: See Jan-Egbert Sturm et al,

--- III. Economic Growth in the 1980s. The best way to compare economic growth in that decade is with the 1990s --- not earlier decades. The reason? The 1975 watershed, when --- because of the oil price surge in 1973-74, the short- and long-term dislocations it caused, and the sudden disarray in policymaking circles when the Phillips curve, faced with a supply-side shock, no longer offered any clear guidance of reconciling low unemployment and a predictable and stable level of inflation --- economic growth in the industrial world slowed down markedly: roughly, by 50% or more in Japan and Germany and most of the EU (though not the poorer EU Mediterranean countries or poor Ireland in those days, which --- in line with standard convergence catch-up growth --- eventually managed to raise their GDP growth rates in the late 1980s and 1990s). In the US, the leader country that had been the slow-grower in the OECD since 1945 --- again, fully in line with convergence theory that predicts that follower countries with proper educational levels in their work force and decent economic and governmental institutions will grow faster than the lead country once they are launched onto a path of sustained growth ---- GDP growth actually slowed down much less, around a third . . . though labor productivity fell off even more (only for labor productivity to rise noticeably and more or less recover its earlier pre-1975 trend).

So what do we find in the 1980s and 1990s, across an entire business cycle: from 1983’s recovery to the short, shallow recession of 1991-92, and from the 1993 recovery to the short-shallow recession of 2001? Real GDP growth from 1983 to 1992, nine years, totaled 31.7%. In the nine years between 1993 and 2001, it totaled 32.6%. (BEA figures: ). Obviously, it’s better to have grown without rising national debt, rather declining debt on the whole; but that isn’t what is germane here. In the 1980-82 period, inflation was averaging nearly 10% a year,, and unemployment was close to averaging 10% too. It was a horrendous period for the US economy. The contributors to this forum seem to think 6.3% unemployment is deplorable, something I agree . . . at a time when inflation is essentially dead in the water, with the Fed claiming to have worried about deflation as a problem this last spring. But 10% unemployment --- the highest we had since the 1930s Great Depression --- and a similar magnitude of inflation were markedly worrying and a huge challenge.

--- IV. In the process of growing rapidly, national debt did rise three fold as Mr. Bakho notes, for once managing to get a figure right. That, however, isn’t the relevant stat. The relevant stat is national debt as a % of GDP. A better picture then of the Reagan years, compared to the previous decades and since, charts this at this site

---- V. In his inimitable manner of reasoning, Mr. Bakho thinks that anyone questioning whether crowding out occurs because of fiscal deficits deserves to be called “stupid” and peppered with “duh”.

Very briefly in response: The strong version advanced by New Classicists, starting with Milton Friedman in the 1960s, holds that rising federal deficits --- financed of course by selling new issues of Treasury securities in loanable markets --- will crowd out private investment by raising interest rates. Unfortunately, the evidence for this --- as I noted in my original comments --- is simply lacking in any convincing manner. If anything, the evidence suggest there is no clear correlation at all. For a chart plotting ten year interest rates against publicly held debt --- based on some good regression analysis --- see

The alternative version developed in the mid-1980s --- when long-term real interest rates turned out not to rise as predicted by crowding-out --- was that the higher short-term interest rates that the Fed purposely set by its ability to control bank reserves (high-powered money) then led to a huge inflow of foreign capital into the US loanable funds market. That was then interpreted to mean that the higher rates were caused by competing sales of Treasury securities in private markets. For clarification, see the buggy prof article for August 22nd, 2003: “What Causes US Trade Deficits, and Should We Worry?” But to illustrate in shorthand here, let me reproduce the equation (derived from national income accounts) found in a book written by someone regarded, apparently, as the economics equivalent of Gospel Truth: Paul Krugman . . . specifically, from his co-authored book with Maurice Obstfeld, International Economics: Theory and Practice (3rd ed), p315:

CA = S (personal savings) – I – (G – T)

CA means Current Account; S is personal household savings, I is net investment, G is government spending, and T is taxes
G-T is the size of a federal surplus with G exceeds T, and vice versa the size of a deficit when G spending outpaces T.

Mr. Bahko seems to think this new crowding out variant is Gospel stuff. In fact, it isn’t. What turns out to be the case is that there is no correlation whatever between current account deficits --- and hence capital account surpluses --- and either the size of US governmental deficits or its trend (toward surplus at the end of the 1990s, at a time of record current account deficits). Again, if Mr. Bakho can control his urges to stutter “duh” and look at the Benjamin Friedman article, he will find some statistical evidence of this (much as it might disturb the cocksure nature of his convictions).

---- VI. Why, exactly, crowding out doesn’t occur in either of the ways that New Classical Economics predicts isn’t clear. Probably the best candidate-theory is Barro’s updated Ricardian view that fiscal deficits have no discernible impact on the macro economy. That’s because when tax cuts aren’t accompanied by declining government spending, the public knows that rising deficits in the present --- financed by borrowing from the public --- will have to be compensated for in the future by new tax rises. The result? The tax cut money is immediately saved for future tax rises, with the triple result that no fiscal stimulus to GDP from higher consumption or investment follows; interest rates don’t rise (because new savings offset the sales of new Treasury securities); and hence if interest rates don’t rise, there’s no correlation between capital inflows from abroad and the fiscal deficit. The trouble is, as I noted in my comments about the problems with macroeconomic theories and policy guides, the Barro thesis has never found unequivocal statistical support in most cases, whether here or abroad. Lots of studies show it applies; lots don’t. Since I believe DeLong discussed this work --- at least a study by Mankiw and someone else --- and did this recently (ever since I started looking at the site not long ago), there’s no need for me to rehearse the (inevitable) uncertainty of the thesis, and the studies that seek to confirm or disconfirm it.

(5) One final point; Paul Krugman

Krugman did some good work once on trade theory amid conditions of monopolistic competition (oligopoly) and the growing role of governments in modern economies that didn’t figure in 19th century and most 20th century work until then. Not that Krugman was alone in developing New Trade theory, let alone the Strategic-Trade Prisoners’ Dilemma variant (which he later renounced anyway). That said, why he has such guru status in the minds of those here remains a puzzle of sorts: specifically, a it’s puzzling to understand why just citing his name or his views in incantatory manner, like a pulpit-pounding evangelist invoking the name of the Deity, is supposed to stop an intellectual discussion like this. Krugman may be right about certain things in his New York Times columns, and he may be wrong; but summoning up his name in adulatory terms does nothing to establish anything (other than naiveté or true-believing adulation, I suppose). Earlier in the last decade, to clarify this, Krugman wrote a book called The Age of Diminished Expectations, which went through, I believe, 3 editions. In it, he predicted that the US economy had fallen on permanently hard times: productivity growth would very likely remain low, per capita income growth would do the same, the US foreign debt would likely cripple the US economy’s future, the high levels of national debt he discerned would do the same. More specifically, he ended up, if I remember --- it’s been about a decade since I looked at the book and I have no copy of my own --- with three scenarios, and the gloomier two seems more likely to materialize than even the slightly dismal one. The outcome? We should all adjust our expectations of economic prosperity and good job-creation downward. The book, as it happened, turned out to be a bust as a sooth-saying work. The exact opposite on all these scores occurred in the years after the book went through its last edition.

Whether this fact dims the glories surrounding his name in these forums is something else. Adulating true-believers seem impervious to discordant realities, however bluntly they collide with their convictions. Does that mean Krugman is always wrong? No, obviously not. But it would help, I believe, if the persons conjuring up his name and columns could reason for themselves, backing up their points with solid evidence, showing some rigor in their analysis, and being less cocksure about their views.

I trust this answers effectively all the people who were kind enough to comment on my earlier commentary.

Posted by: michael gordon on August 24, 2003 10:39 AM


One further set of comments that I should have added earlier --- a few minutes ago --- to deal with Mr. Bakho's rejoinders: Add it to the end of (4) above:

---- VII Mr. Bakho also seems to be some sort of economic nationalist, worried that there’s some sort of huge corporate profits that flow out of the US when foreigners invest here --- presumably, he means FDI, multinational investment. Two or three brief replies. One: if all countries restricted or prohibited multinational investment --- or for that matter portfolio investment ---- the US would be a net loser: the inflow of profits, and payments on US licenses and royalties, each year is a big net plus in the US trade-in-services part of the Current Account: see Two: the outflows of profits to the parent firms of multinational enterprises here are their rewards for creating profitable businesses that employ millions of Americans, add to our GDP and per capita income, and pay taxes to local and federal governments . . . the same as US firms do when they operate abroad. Three: the outflows of the profits don’t presumably go under the mattresses of French, British, Dutch, German, and Japanese multinational CEO’s and equity-holders. They in turn spend or invest them: spend some of US exported goods and services, invest some back here, and do the same in other countries to which we then export in turn.

The only possible objection to be raised to any of this --- except jingoist --- is paying profits on US investments of the Saudis for oil sales, and on political grounds: like all the other 21 Arab countries, Saudi Arabia is a despotism run by a small clique of corrupt self-serving gangster types . . . only with the added twists: that 1) they have squandered even more money through profligate consumption (about 2.5 trillion dollars worth of oil revenue calculated in 2001 dollars) even as per capita income in that country of 20 million or so has fallen by two-thirds since 1980; 2) export a racist, US-hating, anti-western form of Wahhabi Islam with their oil money that fans fundamentalist zeal and hatred around the Muslim world and elsewhere; and 3) have used at least a fair amount of the revenue to support Al Qaeda and other mass-murdering Islamist terrorist movements, which have among other things caused thousands of American deaths. The latest effort of the Bush White House to conceal the Saudi role here that was apparently documented in the recent Congressional study of 9/11’s mass-murder shows just how treacherous these so-called Saudi friends happen to be. Those who want further buggy prof studies can find them here:

The latter, I add, is a political-economy analysis of Israel’s thumping success in fostering a modern economy and democracy, compared to the economic backwardness and despotism rife throughout the Arab Middle East. Surprisingly, as the article shows, Palestinians turn out in survey data to admire Israeli democracy more than any other democratic country.

Posted by: michael gordon on August 24, 2003 11:09 AM


Thanks Buggy -

Will consider, but I have the sense that GDP growth in the US and abroad was more robust in the 1970's than in the 1980's. I will simply look up the data. You argued and answered well, but this deficit is not like that of the 1980's. Will consider carefully and respond.


Posted by: anne on August 24, 2003 01:36 PM


Buggy -

You argue well indeed. From now on I will more carefully read your comments. Suppose your argument is correct about caution on the deficit, though we are an older country than in 1980 or 1990, the least that has been happening in this Administration is that the well-being of middle class households is being threatened. The budget policy of this Administration is designed to undercut social benefit programs by cutting taxes and making the tax system flat to regressive in impact. This Administration has had an awful economic agenda to go with an awful environmental agenda, and foreign aid agenda, and on and on and on.

Posted by: anne on August 24, 2003 01:54 PM


Back from a long walk in the Santa Barbara hills where I live, I found some time on my hands and reproduced this entire discussion at the buggy prof site:

I again thank everybody for their comments, and especially Anne at the very end here.

--- Michael Gordon

Posted by: michael gordon on August 24, 2003 05:04 PM



Posted by: Sincan2 on November 18, 2003 09:02 AM



Posted by: Sincan2 on November 18, 2003 09:05 AM



Posted by: Sincan2 on November 18, 2003 09:08 AM


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