Semi-Daily Journal
Brad DeLong's Thoughts of the Moment on Economics, and on Other Topics as Well
DeLong's Home Page
August 30, 2002
Paul Krugman on the Fiscal Outlook
Back in the early 1990s there were a bunch of us who believed that reducing the deficit--returning American fiscal policy to sanity--would lead to a jump in confidence in America's long-run future, to an increase in investment in America, to a high productivity-growth recovery, and to rapid increases in Americans' incomes. We turned out to be right: economic historians will long argue to what degree the 1990s boom was the result of changes in fiscal policy and to what degree it was the result of other factors, for the magnitude of the productivity boom was far greater than we had hoped for, even in our wildest dreams.
Thus it is very disappointing to see how quickly what I regard as our flagship accomplishment is being reversed by the Bush administration and the current congress.
Here Paul Krugman sums up the story so far:
Just Paul Krugman: Trust Us: The story so far:
Summer 2000: Candidate George W. Bush assures voters that his tax cut is affordable. He illustrates his point with four $1 bills. One bill, he says, represents the tax cut; one represents new programs, such as prescription drug coverage; the other two are funds set aside to pay down debt, strengthening Social Security. He pledges, without qualification, not to dip into the Social Security surplus.
Spring 2001: The Bush administration pushes its tax cut through Congress. Officials dismiss concerns that projections of a huge surplus may be excessively optimistic, assuring Congressmen that the projections are actually on the low side. Mr. Bush also claims that his budget includes a trillion-dollar reserve, enough to deal with any contingency....
August 2002: The nonpartisan Congressional Budget Office issues a much grimmer projection, with a 2003 deficit twice that predicted by the administration, and deficits persisting until 2006. Moreover, the C.B.O. is required by law to make unrealistic assumptions that cause it to understate future deficits. A new analysis by Goldman Sachs, which is not under these constraints, predicts deficits well over $100 billion each year for the rest of the decade.
This $7 trillion reversal of fiscal fortune has received remarkably little public attention; it has been crowded off the front page by talk of war. But its consequences will be immense. Where did the surplus go? The "trifecta" is not the main story; recessions have only a small impact on long-run projections, and the Center on Budget and Policy Priorities calculates that increases in military and homeland security spending account for only 16 percent of the 10-year deterioration in the C.B.O. projection. In fact, it's clear that we would be facing large deficits outside Social Security, and probably significant deficits in the budget as a whole, even if neither the recession nor Sept. 11 had happened.
The two main culprits are the tax cut and "technical changes" in the estimates: perhaps because of the end of the bull market, a given level of G.D.P. is yielding much less revenue than it did during the late 1990's. Or to put it another way, our brief era of big surpluses seems to have been a fluke...
August 30, 2002
Just Trust Us
By PAUL KRUGMAN
he story so far:
Summer 2000: Candidate George W. Bush assures voters that his tax cut is affordable. He illustrates his point with four $1 bills. One bill, he says, represents the tax cut; one represents new programs, such as prescription drug coverage; the other two are funds set aside to pay down debt, strengthening Social Security. He pledges, without qualification, not to dip into the Social Security surplus.
Spring 2001: The Bush administration pushes its tax cut through Congress. Officials dismiss concerns that projections of a huge surplus may be excessively optimistic, assuring Congressmen that the projections are actually on the low side. Mr. Bush also claims that his budget includes a trillion-dollar reserve, enough to deal with any contingency.
Summer 2001: Just weeks after the tax cut passes, officials reveal that tax receipts have been coming in far below expectations. Budget projections are revised sharply downward, but the administration still claims that it will run an overall surplus greater than the Social Security surplus, that is, more than $150 billion per year. The administration also claims that the tax cut, conceived at a time of runaway boom, is exactly the right medicine for an ailing economy.
October 2001: "Lucky me: I hit the trifecta." So remarks Mr. Bush, claiming that recession, national emergency and war have let him off the hook on his budget promises. Though some think that it's in bad taste, the trifecta joke becomes part of Mr. Bush's standard stump speech. He claims to have made this exception to his budget pledges during the 2000 campaign, but there is no record of his having done so.
November 2001: Budget director Mitch Daniels admits that the overall budget — not just the budget outside Social Security — will actually be in deficit for fiscal 2002.
July 2002: The White House admits that the deficit for fiscal 2002, which ends in September, will be $165 billion — a non-Social-Security deficit of $322 billion. But it still says that the budget will be back in surplus by 2004.
August 2002: The nonpartisan Congressional Budget Office issues a much grimmer projection, with a 2003 deficit twice that predicted by the administration, and deficits persisting until 2006. Moreover, the C.B.O. is required by law to make unrealistic assumptions that cause it to understate future deficits. A new analysis by Goldman Sachs, which is not under these constraints, predicts deficits well over $100 billion each year for the rest of the decade.
This $7 trillion reversal of fiscal fortune has received remarkably little public attention; it has been crowded off the front page by talk of war. But its consequences will be immense.
Where did the surplus go? The "trifecta" is not the main story; recessions have only a small impact on long-run projections, and the Center on Budget and Policy Priorities calculates that increases in military and homeland security spending account for only 16 percent of the 10-year deterioration in the C.B.O. projection. In fact, it's clear that we would be facing large deficits outside Social Security, and probably significant deficits in the budget as a whole, even if neither the recession nor Sept. 11 had happened.
The two main culprits are the tax cut and "technical changes" in the estimates: perhaps because of the end of the bull market, a given level of G.D.P. is yielding much less revenue than it did during the late 1990's. Or to put it another way, our brief era of big surpluses seems to have been a fluke.
Despite assurances that the tax cut would promote recovery, the economy seems to be sputtering. Early indications are that the administration will propose another round of tax cuts, all of them aimed at stock market investors. It's important to notice that such measures as increased deductions for capital losses provide no benefit to those whose investment takes place through 401(k) plans; so these tax breaks are mainly for the very affluent. A careful analysis by William Gale and Peter Orszag — experts at Brookings who have consistently, and correctly, warned that administration budget projections were overoptimistic — shows that these measures will be ineffective as stimulus, and will further worsen the budget outlook.
Of course, administration officials will brush this aside, assuring us that their proposals are just what the nation needs. Can anyone think of a reason not to trust them?
Posted by DeLong at August 30, 2002 12:51 PM
| Trackback
To take credit for these accomplishments is too much. The phrase "returning America to fiscal sanity" is ambigious: does it mean small budget deficits, the size of the budget in relation to the size of the economy, the rate of spending increases, or something else?
There was one long term trend and two shorter term events that better explain the 1990's economic growth. The long term trend is the decline in interest rates and inflation since the early 1980's. A graph of the two over the past 25 or 30 years shows them both heading down.
The two shorter term events were the commercialization of the internet and Y2K. Both encouraged a ton of technology spending, and the resultant increase in growth and productivity. Businesses can now use the internet share data in a relatively inexpensive and fast way. They don't have to copy data to tapes and send them by messenger, for example. Y2K gave everybody a reason to ditch their old technology for upgrades. My employer replaced their old mini and mainframe computers for unix servers.
These events occurred regardless of "American fiscal policy".
>>These events occurred regardless of "American fiscal policy".<<
No they didn't. Businesses have to obtain the financial resources to fund investment from somewhere. If a dollar is borrowed by the Treasury it can't purchase a share of stock in an IPO or be channeled into a bond fund.
It's important to think about the whole system, not about one piece of it. It's important to think about why interest rates went down, not to take their decline as a simple unexplained fact of nature.
OK the Bush administration is an economic catastrophe, but was the Clinton administration much better?
My impression, perhaps incorrect, is that the Clinton-Rubin administration (with the help of Alan Greenspan, notwithstanding his plea of powerlessness yesterday) allowed a bubble to develop in the economy. The budget surpluses would seem to have come from the bubble economy and not any wise economic stewardship.
To take another example, Rubin's bailout of Mexico may have been good for the economy at that time (what's good for Goldman Sachs is good for the country...?), but by increasing moral hazard, it simply meant that there would be more serious problems in the future. Now we are paying the piper in South America and elsewhere.
So again, I think the Bush administration has handled the post-bubble economy terribly, but that does not get the Clinton administration off the hook. Perhaps Bush will go down as the Herbert Hoover of our era; but then Clinton will go down as the Calvin Coolidge.
You still did not answer my question.
I understand the crowding out theory, and I gave an explanation, maybe obtusely, for a decline in interest rates: lower inflation. A graph of inflation and interest rates shows them moving together, but not always at the same time. Plus, the reason I always hear when rates are raised is that the economy might overheat, thus sparking inflation. So we had occasional increases in interest rates along the 20+ year way.
If you are referring to some aspect of the budget deficit, the Clinton admin. forecast $200 billion deficits every year into the future. They were not making the case that a smaller deficit reduced interest rates. They were not even concerned about deficits. They offered an "economic stimulus" plan that would have increased the deficit. They tried to nationalize health care, which would have entailed enormous government spending to hire people, construct the buildings, and pay for the services. Maybe you have the estimates.
Y2K conversion had to happen because computer systems were unable to handle the date change. Being a technology professional in the financial services industry I can tell you that from experience. I worked on such a project. I remember looking to invest in companies that provided the tools to make the conversion. If capital was scarce, businesses probably would have laid off more people, or maybe more foreigners would have invested here, or maybe Americans would have.
The correlation between inflation and interest rates isn't as clear as it is made up to be. It should be remembered that in 1993-94, long rates went UP, not down. The down coincides with(though I think Brad and I would agree that it's not because of) the Gingrich win in 1994. You even get a 70 basis point backup in the first half of 1997. (You can use www.economagic.com to verify this.)
I think most certainly the increase in capital inflows to the US after the East Asian collapse has much to do with the second step down in interest rates. If one wishes to claim that "our flagship accomplishment", well, be my guest.
Responsible fiscal and monetary policy produced a high growth low unemployment economy during the Clinton years. If there base had been set for a productivity surge by 20 years of growth in computer usage, fine. Income inequality trends slowed, and women and minorities made considerable economic progress. We have gone from responsible fiscal policy to irresponsible policy designed to excessively reward the wealthiest of Americans.
The Clinton administration did not try to nationalize health care. It tried with no success to induce the present health care and insurance industry to cover millions of working Americans who have no health care coverage.
The administration was successful for a time in limiting price increases in health care by inducing greater HMO usage and jaw boning the drug industry about prices for drugs on patent.
From Krugman's column:
"perhaps because of the end of the bull market, a given level of G.D.P. is yielding much less revenue than it did during the late 1990's. Or to put it another way, our brief era of big surpluses seems to have been a fluke... "
Sorry, was this the fiscal sanity of which you spoke? I think the tech bubble may have inflated government tax receipts through capital gains and exercise of stock options.
Also, I wonder about the reported productivity gains: if a significant part of the economy was devoted to tech activites that, after the fact, were highly over-valued, then might one argue that GDP and productivity were overstated? All quite irregular and ex-post, of course, but this bubble was quite extraordinary.
Regards,
The bubble was based on expectations of future earnings among tech companies. That the future expectations turned out to exceed realistic valuations does not mean that GDP and productivity -- all measured after the fact, rather than based on future expectations -- were overstated, though in practice they often were, somewhat. (2000's growth downgraded from 5% to 4.3% and such, though that was an unusually big downgrade unless I'm mistaken.)
Julian Elson
Krueger at Princeton and Merrill Lynch have shown that the GDP growth reductions were not unusual. Also, America has done a better job at tracking national income accounts than other major economies.
Productivity growth did indeed pick up after 1995 and is likely to continue at a nice pace, however as Krugman and Warren Buffett have pointed out, productivity acceleration may not mean higher corporate earnings. Recent productivity growth may be aiding consumers through price reductions rather than producers.
The internet is wonderful for consumers, producers have generally been made more competitive with internet useage.
'To take another example, Rubin's bailout of Mexico may have been good for the economy at that time (what's good for Goldman Sachs is good for the country...?), but by increasing moral hazard, it simply meant that there would be more serious problems in the future. Now we are paying the piper in South America and elsewhere.'
International currency crises are subject to moral hazard? Huh?
'Sorry, was this the fiscal sanity of which you spoke? I think the tech bubble may have inflated government tax receipts through capital gains and exercise of stock options.'
I seem to remember a certain presidential candidate declaring there was enough money in the non-social security surplus for a prescription drug benefit, tax cut, and contingency fund.
Re:
>>OK the Bush administration is an economic catastrophe, but was the Clinton administration much better?<<
Oh God yes! Fastest growth and lowest unemployment in a generation. Due to luck, skill, and more luck by those running economic policy...
The idea that the current problems in Argentina and Brazil can be linked to our aid to Mexico seems absurd. American aid to Mexico has allowed for a continued advance of democracy and economic growth that has continued through our recession.
Argentina did all we asked of it in adopting a dollar peg. Brazil has a highly responsible fiscal and monetary policy, and is trying to address the needs of the poor.
To abandon Mexico would have been a terrible betrayal of our friend and neighbor. Unthinkable. Argentina was continually advised to keep the currency peg as the economy faltered. We should have urged the peg be adjusted. Brazil has been hurt by Argentina, by the global slowing, by capital flight as an election looms. We were right to shore up Brazil, another friend, and should have further helped Aregentina, again a friend.
The scariest thing I find in these postings and looking at comments from the Administration concerning Brazil is that the bail out of Mexico was a mistake that led to more crisis. It must be said that the Mexican bailout and a number of other moves they made proactively prevented the sort of crisis that have become common place under the Bush administration.
In the case of Argentina Larry Summers actually issued a warning on the currency peg to the effect well you can do this but you give up all control of your macroeconomy.
As far as the stated goals, theory and general approach of an administration to the economy ."The Economic Report of the President" makes wonderfuil reading. Under the Reagan administration they said tax cuts would lead to surpluses or a balanced budget because they would lead to historically high growsth rates-by historically high rates I mean extended growth at double the historic long term growth rate of the United States.
Under Clinton one at least got some reasonable theory-That the deficits were driving up interest rates-That by reducing them we could not only reduce those interest rates but it would give the fed greater freedom to also lower them. Fiscal and monetray poolicy could thus work in the same direction. Initially there was a small stimulus package that was rejected by Congress. The thing that most struck me about the Clinton administration was how conservative their projections were. If they had a choice between make a rosy projection and a conservative projection they always chose the conservative one. This was actuall smart politics because it allowed them to say we "exceeded our ecpectations."
Finally a bubble in the stock market does not mean we had a bubble in the economy. The two are not necessarilly connected. Furthermore the productivity numbers, could not have been skewed by this without some very strange theories beingh invoked. During the nineties workers began to produce more goods per hour than they had previously.
Lawrence Boyd