January 11, 2004

Notes: Mankiw Quotes File

The N. Gregory Mankiw Fiscal Policy Quotes File

Deficits And Economic Priorities (washingtonpost.com): The administration's budget update, released yesterday, shows the economic recovery is picking up steam. It also shows a budget deficit for 2004 of $475 billion.... [U]nder the president's proposals, the deficit will shrink from 4.2 percent of gross domestic product in 2004 to 1.7 percent in 2008. The key to achieving this is more-rapid economic growth, which will bring in more tax revenue, together with restraint in the growth of government spending. Because the deficit is shrinking, the accumulated level of national debt is not expected to become problematic...

The corporate income tax is popular in part because it appears to be paid by rich corporations. Yet those who bear the ultimate burden of the tax--the customers and workers of corporations--are often not rich. If the true incidence of the corporate tax were more widely known, this tax might be less popular among voters. (p. 255, Principles of Economics, N. Gregory Mankiw, The Dryden Press/Harcourt Brace, 1998) So this tax cannot impede investment and economic growth, insofar as such investment and growth is due to corporations. They should be indifferent to the tax, and they are wasting a lot of lobbying dollars combating it. By the same token, if the true incidence were more widely known in the White House, this tax might be more popular...

Thus, the most basic lesson about budget deficits follows directly from their effects on the supply and demand for loanable funds: When the government reduces national saving by running a budget deficit, the interest rate rises, and investment falls. Because investment is important for long-run economic growth, government budget deficits reduce the economy's growth rate. (p. 557, Principles of Economics, N. Gregory Mankiw, The Dryden Press/Harcourt Brace, 1998)

THE NEW YORK TIMES Nov. 27, 2001 To The Editor: Robert F. Kennedy Jr. ("Better Gas Mileage, Greater Security," Op-Ed, Nov. 24) may be right that reduced gasoline consumption should be a national goal. But I disagree with his proposal for how to achieve it. Command-and-control solutions like the corporate average fuel economy, or CAFE, standards, are rarely the best approach to correcting decisions made in a free market. Such regulation not only is intrusive but also gives insufficient incentive to car makers once the standard is met and gives no incentive for car owners to drive less. It would be better to use a corrective tax, like the tax on gasoline. A higher gasoline tax could be coupled with lower income taxes. Politically this should be a win-win proposition, for it would appeal to Democratic environmentalists and Republican supply-siders, as well as those who believe that dependence on foreign oil is a threat to national security. N. GREGORY MANKIW Cambridge, Mass., Nov. 24, 2001 The writer is a professor of economics at Harvard University.

When the government spends more than it receives in tax revenues, the shortfall is called a budget deficit. The accumulation of past budget deficits is called the government debt. In recent years, the U.S. federal government has run large budget deficits, resulting in a rapidly growing government debt. As a result, much debate has centered on the effects of these deficits both on the allocation of the economy's scarce resources and on long-term economic growth. . . . When the government spends more than it receives in tax revenue, the resulting budget deficit lowers national saving. The supply of loanable funds decreases, and the equilibrium interest rate rises. Thus, when the government borrows to finance its budget deficit, it crowds out households and firms who otherwise would borrow to finance investment. (Page 555, Principles of Economics, N. Gregory Mankiw, The Dryden Press/Harcourt Brace, 1998.)

N. Gregory Mankiw (1998), Principles of Economics (New York: Dryden: 0030982383). Thinking Like an Economist: Why Economists Disagree: Charlatans and Cranks: pp. 29-30: An example of fad economics occurred in 1980, when a small group fo economists advised presidential candidate Ronald Reagan that an across-the-board cut in income tax rates would raise tax revenue. They argued that if people could keep a higher fraction of their income, people would work harder to earn more income. Even though tax rates would be lower, income would raise by so much, they claimed, that tax revenue would rise. Almost all professional economists, including most of those who supported Reagan's proposal to cut taxes, viewed this outcome as too optimistic. Lower tax rates might encourage people to work harder, and this extra effort would offset the direct effects of lower tax rates to some extent. But there was no credible evidence that work effort would rise by enough to caues tax revenues to rise in the face of lower tax rates. George Bush, also a presidential candidate in 1980, agreed with most of the professional economists: He called this idea "voodoo economics." Nonetheless, the argument was appealing to Reagan, and it shaped the 1980 presidential campaign and the economic policies of the 1980s.... Congress passes the cut in tax rates... but the tax cut did not cause tax revenue to rise... tax revenue fell... government began a long period of deficit spending... largest peacetime increase in the government debt in U.S. history. Fads can make experts seem less united than the actually are... when the economics profession appears in disarry, you should ask whether the disagreement is real or manufactured... [by] some snake-oil salesman who is trying to sell a miracle cure...

Elmendorf and Mankiw (1998): With these caveats in mind, it is worth noting that this literature has typically supported the Ricardian view that budget deficits have no effect on interest rates.... Our view is that this literature, like the literature regarding the effect of fiscal policy on consumption, is ultimately not very informative. Examined carefully, the results are simply too hard to swallow, for three reasons. First, the estimated effects of policy variables are often not robust to changes in sample period or specification. Second, the measures of expectations included in the regressions generally explain only a small part of the total variation in interest rates. For example, the average R-squared of Plosser's basic monthly regressions (1987, tables 6 and 7) is .06, and the corresponding value of Evans's basic quarterly regressions (1987b, tabled 1) is .09. This poor fit suggests some combination of measurement error in expectations and the omission of other relevant (and possibly correlated) variables. Under either explanation, the estimated coefficients on the policy variables must be viewed with skepticism. Third, Plosser (1987) and Evans (1987b) generally cannot reject the hypothesis that government spending, taxes, and monetary policy each have no effect on interest rates. Plosser (1987) also reports that expected inflation has no significant effect on nominal interest rates. These findings suggest this framework has little power to measure the true effects of policy...

"Naturally the budget deficit is a cause for concern," Gregory Mankiw, chief economic adviser to President George W. Bush, told Germany's Handelsblatt newspaper. "It could push up interest rates."...

Elmendorf and Mankiw (1998): We have now quantified, in a very rough way, some long-run effects of government debt on the economy. The debt fairy parable implied that each dollar of debt reduces net output by about six cents each year. More careful consideration of the strong assumptions embodied in that parable suggested that this estimated cost is at least in the right ballpark. The deadweight loss from the taxes needed to service the debt adds about another one cent per dollar of debt. Thus, the U.S. debt of the late 1990s, which equals about half of annual output, is reducing net output by about 3.5 percent. In 1997, this amounts to around $300 billion per year.

Elmendorf and Mankiw (1998): As concern about current and prospective U.S. budget deficits has grown, quantitative estimates of the effect of debt have begun to appear in official U.S. government documents. For example, the 1994 Economic Report of the President (pp. 85-87) assumed that the President's deficit-reduction plan would boost national saving by 1 percent of output each year for 50 years. Then the Report used a simple Solow growth model to show the effect of that extra saving on the economy. It concluded that the additional saving would eventually raise output by 3.75 percent. More recently, the Congressional Budget Office (CBO, 1997b) constructed a complex model of the economy and the federal budget and simulated the model through the year 2050. Because current law would produce an explosive rise in the national debt over that period, CBO's results do not reflect steady-state effects. In the simulation that includes the economic effects of increasing debt, debt rises by 30 percent of output by 2020, resulting in output that is 2 percent smaller than it otherwise would be. Over the following decade, debt increases by another 80 percent of output, and output is diminished by more than 8 percent relative to the same baseline. Thus, these calculations are similar in spirit to those found in the academic literature.

Posted by DeLong at January 11, 2004 09:25 AM | TrackBack

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