January 07, 2003
It's Time for Glenn Hubbard to Quit as CEA Chair

It's Time for Glenn Hubbard to Quit as CEA Chair

On December 18th, the Wall Street Journal's Bob Davis reported:


To sell a package of tax cuts that will further deepen the budget deficit, the White House says that deficits don't matter. Is that true? Certainly, says Glenn Hubbard, chairman of the White House's Council of Economic Advisers. He derides the "current fixation" with budget deficits, and labels as "nonsense" and "Rubinomics" the view espoused by former Clinton Treasury Secretary Robert Rubin that higher deficits lead to lower growth.


From this I conclude that it is time for Glenn Hubbard to leave his post as Chair of the Council of Economic Advisers. He badly needs to get back to Columbia University. I do not say this because I wish Glenn ill. If I wished Glenn ill I would urge him to continue on his current course, for on it he will rapidly do severe, permanent, and irreparable harm to his standing within the community of economists, to his reputation, and to his own intellectual integrity.

Economists holding high political office are always walking a tightrope, trying to (a) assist an administration with whose policies they gradually agree and (b) influence those policies in a generally positive direction, on the one hand, while avoiding (c) lowering the level of the debate and (d) destroying their future academic credibility by saying things that are simply false. They are walking an incredibly difficult tightrope. The pressures are immense. No one can walk the tightrope forever: Murray Weidenbaum lasted last than a month, and rare is the economist who can successfully walk the tightrope for more than a couple of years.

When they fall off the tightrope, the results are not pretty. Once White House Media Affairs knows that you have lied because you want to be a team player and want to keep your White House Mess privileges, you become somebody whose assent and cooperation is not needed. Everyone knows that you will always do your part at the end. So whatever points you make and positions you take get rapidly overridden by the Chief of Staff, if not ignored completely: there are lots of other factions inside and outside the White House whose assent is necessary and cannot be taken for granted. You, by contrast, have prostituted yourself once. You can be counted on to prostitute yourself again. Thus you have no power.

The classic example of this in our day is the case of Murray Weidenbaum, who arrived at the White House at the start of the Reagan Administration eager to be a team player. After his year and a half as Chair of the Reagan Council of Economic Advisers shilling for the policies that created the huge federal deficits of the 1980s, he had shredded his outside-the-White-House academic reputation. During his year and a half, he had no inside-the-White-House power at all--for it was clear that he would be a docile talking head whether he was listened to or not. And at the end of his year and a half, he was invited by the White House insiders to spend more time with his family--for with the economy in recession, they decided that the benefits to having someone else with an intact academic reputation in the job outweighed the benefits of having a rubber stamp.

Glenn Hubbard has gotten himself into a Weidenbaum-like position by signing on to the deficits-don't-matter campaign. He has thus told White House Media Affairs that his desire to cooperate with the team outweighs both his need to keep his academic reputation by associating himself with only the good arguments and his need to be part of a process that makes policies that are good for America. Thus his power to shape the White House's view of economic policy for good is gone. And all that he can do if he stays in the administration is to shred his own intellectual reputation.

Truth be told, if you are going to barter away pieces of your academic reputation for insider status and White House Mess privileges, saying that deficits don't matter--that they do not affect interest rates or rates of economic growth--is not the way to go.* You see, the claim that deficits matter for long-run interest rates is based on the first lesson taught the very first day of freshman economics: that demand curves slope down. And the claim that interest rates matter for investment and long-run growth is based on the second lesson taught the very second day of freshman economics: that supply curves slope up.

Businesses and the government bring bonds to the bond market, trying to sell them either to raise money to finance investment (if you are a business) or to finance your deficit (if you are the government). A bigger government deficit increases the supply of such bonds. To take up that supply--for the market to clear--the economy has to move down the demand curve: some people who thought government bonds were no bargain and who refused to buy them at $1000 will buy them at a price of $980. Thus a higher supply of bonds to be sold on the market lowers the price of bonds--and a lower price of bonds is the same thing as a higher interest rate. A higher interest rate reduces investment because supply curves slope up: a lower price of bonds in the market leads businesses to sell fewer of them. Some businesses that would have sold bonds if they could at $1000 each will hold back and cancel the sale if the best they can expect to get is $980. The investment projects that those bond sales were supposed to finance will be canceled or delayed. The rate at which America's productive capital stock grows will be reduced, with less capital the economy will produce less, and economic growth will slow.

Now you can argue that sometimes--one time in a hundred, perhaps--demand curves don't slope down, and supply curves don't slope up. You can get a pretty good job as a professor at an Ivy League-class school by demonstrating an example of such a case, or even an argument that there might be such a case. But there is no reason to think that the bond market is special in this way for persistent, long-term deficits--those that last a decade or more. (There is reason to think that short-term, stimulative deficits during a business cycle recession have little or no effect on interest rates, for if deficits raise demand they raise short-run incomes, and higher short-run incomes mean higher saving.) The argument that long-run deficits don't affect interest rates applies only to (a) a small economy that is (b) open to trade and capital flows and (c) possesses a fixed exchange rate. Such an economy finds that its interest rates are determined by what happens abroad, not by what happens at home. But the United States is not a small economy. The United States does not have a fixed exchange rate.

What an honest economic adviser would say is that a long-term deficit certainly does raise interest rates, certainly does reduce investment, and certainly does put a drag on long-run economic growth. She would say that we really don't know how large the drag is, but that there is no good reason to think that it can be neglected as small, and some good reason to think it is large. She would say that that is what we know, that those are facts about our knowledge of the world, and that they need to be taken into account when White Houses devise economic policies. That's the job of a Council of Economic Advisers chair: to make sure that the High Politicians in the White House deal with the facts of policies rather than the fantasies of Media Affairs.

But a Council of Economic Advisers chair whom White House Media Affairs believes it has tamed cannot be a voice making the White House take facts into account. Glenn Hubbard has been so tamed. He cannot do his job any more.


*In Glenn's case, he is in even worse shape than your average economist to say that deficits don't matter for interest rates. You see, in 2002 Pearson Publishing published the fourth edition of Glenn Hubbard's Money, the Financial System, and the Economy. And this book certainly teaches that higher deficits raise interest rates. In fact, on page 661 there is an explicit formula: Let "a" stand for the amount by which a unit increase in interest rates reduces investment; let "d" stand for the amount by which a unit increase in interest rates reduces net exports let "c1" stand for the marginal propensity to consume, and let "c2quot; stand for the amount by which an increase in interest rates increases household savings. Then equation 24A.10 tells us that a one-dollar increase in government spending raises interest rates by:

(1/(c2 + a + d))

And a one-dollar decrease in taxes raises interest rates by:

(c1/(c2 + a + d))

If thinks "Rubinomics" is so wrong, why teach it to all of your own students and to all the students who use your textbook? If the effects of deficits on interest rates are so small, why bother to distinguish between small open economies with fixed exchange rates (in which the effects are small) and large open economies like the United States?


Addendum: As of January 4, Glenn is getting considerably less coherent:

Washington Post
Low Taxes and Growth for All
January 4, 2003; Page A15

A Dec. 16 news story in your paper stating that a Republican economist does not care about the deficit and wants to raise the tax burden on the poor was too good for Michael Kinsley to check ["Republicans Go Positive on the Deficit," op-ed, Dec. 23]. Had he checked the complete text of my Dec. 10 speech, it would have been clear that I believe the fiscal position does matter and that a pro-growth policy with lower taxes for everybody makes sense.

The president is committed to fiscal discipline, and he rightly believes it is important to balance the budget. The deficit we now face is caused by national emergency, war and recession. We must keep in mind that growth leads to surpluses, not vice versa. Promoting economic growth and job creation is the aim of the administration--and this will lead back to a balanced budget. At the same time, the peer-reviewed economics literature shows that long-term interest rates do not go up in lockstop with the budget deficit. This is apparent from recent history.

The Dec. 16 article and Kinsley suggest that by acknowledging the challenges inherent in fundamental tax reform, the administration favors increasing taxes for some individuals. But the record makes clear this is not the case: The president and this administration know that lowering taxes for everybody leads to growth. This continues to be the sound policy of the administration.

-- R. Glenn Hubband, Chairman, Council of Economic Advisers

Cut taxes for everyone, reduce national savings and investment, and somehow this is going to restore the federal government surplus. Pathetic.

Posted by DeLong at January 07, 2003 03:25 PM | Trackback

Email this entry
Email a link to this entry to:


Your email address:


Message (optional):


Comments

Check out this screed for a more detailed justification. Next they'll be telling us that Eurasia has always been at war with Eastasia.

Posted by: er333 on January 6, 2003 08:53 PM

Far be it from me to argue against what is apparently accepted by every economist good and true, but (as has been recently argued on this blog) there are two objections one might raise.

The first, and most important, is the historical one: there is no correlation, that I or much better informed analysts can find, between deficits and long term interest rates. The previous claim was that it was bondholders "expectations" that would do it. You now claim that it is "decadelong" deficits that are so evil. So, the decadelong deficits during the 80's caused high interest rates and slow growth in the 90s? (We won't even get into why, if it is simply a matter of "demand curves slope downwards", there should be such a long lag between cause and effect; if a producer of say, oil, floods the market with new supply, the price drops immediately - why would bonds be any different?)

The other arguement is with your theory. You are argueing that a govenment deficit "crowds out" by flooding the market with new bonds. But aren't you neglecting the other side of the equation? In running a deficit, the government is creating new bonds, but also creating an equal amount of new money. Couldn't that new money have a teeny affect on the demand for bonds?

I admire and agree with most of what you say on this blog, Brad - but stuff like this makes me want to bang MY head against the wall...

Posted by: jimbo on January 6, 2003 09:42 PM

Note: I don't for one second think that anyone in the Bush administration actually agrees with my analysis, or has even thought much about the question at all. They will say anything that bolsters the case for their preexisting agenda - that much I agree with. But even a broken clock is right twice a day...

Posted by: jimbo on January 6, 2003 10:03 PM

>>In running a deficit, the government is creating new bonds, but also creating an equal amount of new money. Couldn't that new money have a teeny affect on the demand for bonds?<<

New money is created only if the Federal Reserve buys a bunch of the bonds for cash--that's how the new money gets into the economy. If you want to think of a policy that (a) runs a deficit, and (b) has the central bank buy a lot of bonds for newly-printed cash, then I agree things are different.

But that's not what our Federal Reserve has done, is doing, or will do.

Posted by: Brad DeLong on January 6, 2003 10:09 PM

It should also be an interesting baptism-by-fire for the new "economic team" ... studying up the White House plan, taking sidelong glances at the Pelosi plan and thinking "gee, that makes a lot of sense ...".

Posted by: RonK, Seattle on January 6, 2003 10:31 PM

Sheesh. I'll argue in favor of Bush's foreign policy. But his economic policy is just painfully obtuse. There's no getting around it.

Posted by: Erich Schwarz on January 7, 2003 01:10 AM

Bravo. I think this is probably the best Brad DeLong piece I've ever read as well as the best explanation as to why long term deficits hurt investment. I hope he'll submit it to a few publications like TNR or the NYT.

Posted by: Bobby on January 7, 2003 03:55 AM

Very nice. The #1 method for helping people who have fallen under the sway of a cult is to talk to them about the places from whence they came. You remind them of their nostoglia about the communities of their roots. You help them strenghten their ties to those other communties. It reminds them that it isn't desirable to terminate all their connections with their other communities. Meanwhile of course the cult strives to force it's victum is painful choices about his loyalities. It will make it clear that to leave the cult is sucide. They will alternately threat/treat him as he moves out/in - a process that weakens/strengthens the connection building to the new community. To help you have to help them remember who they are. Help them to realize what the cult is trying to make them become.

I wonder if one could organize a campaign by his proffesional associates in a manner similar to the way the police always bring the mother to the scene of a sucide jumper.

Posted by: Ben Hyde on January 7, 2003 05:35 AM

Brad,

I was going to write upo something about "net" money creation, but then it occured to me that I had been missing something fundamental. Then it occured to me that you were missing it, too - and that meant that the economics profession as currently constituted was probably missing it. And that might be important.

See, I had been looking at the flows of government money, in and out of the federal reserve, and seeing it as a special case where money was ejected out one end at the same time it was taken in at the other, so the money was not being "used up", and you could not say that "demand" was being reduced.

But then I realized that government was NOT a special case - the same damn thing happens every time someone borrows or lends money. Then I started to think that applying the normally very useful concepts of "supply" and "demand" to financial instruments was completely illogical.

When you're looking at something like, say, apples, it's logical to say, one the one hand you have a demand curve for apples, on the other hand you have a supply curve. Consumers transfer money to producers, producers transfer apples to consumers, and everybody's happy. For this kind of analysis, we can assume it's a one-time transfer - that the producers get the money, put it in the bank, and are done.

But... what happens when we try to model the bond market the same way? First off, in the case of a new bond issue, we can't even put our hands on the "supply" - the bonds are not created, and then sold - they are created by the very act of selling them. But furthur, even in the case of preexisiting bonds, we can no longer safely neglect the money that ends up in the hands of the "producer" - that money is not destroyed, after all, and the entity that sold the bonds has to do something with it now. Whether it exchanges it for another financial instrument or spends it, the money continues to move around. We can't treat the bond market as a simple exchange of a stock of money for a stock of bonds - we really need to look at it as a continuous flow of money, with the creation of bonds as a byproduct.

Here's a simple model that I hope illustrates what I'm talking about: assume an economy of 4 players: A, B, C, and D. All the players completely trust each other, and know that the others will pay back 100% of all money owed. When we start off, A is the only one that has any money, $100 (where that money came from is interesting, but for the moment let's assume it's exogenous).

So let's assume things go as follows: A loans his $100 to B. (no interest, since to A, B's IOU is just as good as cash - he demands no risk premium) We now have $100 in cash, $100 in IOUs. If B then turns around and lends the same money to C, we still have $100 cash, but we now have $200 IOUs. And if C lends to D, we end up with $300 total in IOUs, but still only the same $100 cash.

But we don't have to stop there. We could keep recycling the same cash back through C, B, and A - in our 100% trust economy, there is no upper limit on how much "debt" can be created. Each player could be holding $50 billion in IOUs issued by the other players. The only limit is the ability and willingness of the players to take on new debt. (infinite, in our example).

The same is true in the real world: there is no "supply" and "demand" of financial instruments - there is only willingness to lend and borrow. The interest rate is determined by the interactions of these propensities.

I better end this now, but I hope I made at least a little bit of sense...

Posted by: jimbo on January 7, 2003 06:07 AM

jimbo,

the fundamental flaw with your argument is the assumption that A lends it to B interest free since it is risk-free.

Indeed, the supply demand relationship will go away if there is no cost. Not just for money, but for anything, including apples.

Throw in an interest cost. Make B pay an interest to A for the privilege of separating A from his cash. Now think that one through.

Unless you are willing to buy Government bonds at zero interest, deficits created by government bonds MUST affect interest rates.

Brad is totally right on this one.

Posted by: Suresh Krishnamoorthy on January 7, 2003 06:27 AM

Well, surely the key as to whether or not "deficits matter" is the *degree* to which they affect interest rates. If larger deficits increase interest rates by only an insignificant amount, then while they do increase rates they don't matter practically as to policy, and everyone can be happy. ;-)

No statement is made above regarding the amount by which deficits affect interest rates. Without that the argument is not complete, so Hubbard really shouldn't oughta have to resign yet.

>>You see, the claim that deficits matter for long-run interest rates is based on the first lesson taught the very first day of freshman economics: that demand curves slope down.<<

Which is not sufficient to prove there is any effect meaningful enough to "matter".

Demand curves slope down for everything, cars too. About 7 million cars are produced in the US annually. If the government increases its purchases of them by, say, 2,800 annually (0.0004 of production) this same iron logic says the price of cars would go up. Irrefutably. But would it go up by an amount anyone would notice?

The amount of supply relative to change in demand, and elasticity of supply, matter too.

Over a trillion dollars trade in world markets each day. To finance a $100 billion increase in the deficit requires that the government borrow less than 0.0004 of them per day. And the money supply is elastic.

In reality, the idea that significant changes in rates result from this simple supply/demand effect seems refuted by the data surveyed by Gale and Orszag, referred to some days ago...

>> Of the 42 studies examined, 17 found a “predominately significant, positive” effect of deficits on interest rates (that is, larger deficits increased interest rates); 6 found mixed effects; and 19 found “predominately insignificant or negative” effects ..." Reflecting the variation in results, Elmendorf and Mankiw (1999) conclude that “Our view is that this literature...is not very informative.” Bernheim (1989) writes that “it is easy to cite a large number of studies that support any conceivable position.” <<

But if it is really so *self evident* that rising deficits increase interest rates *significantly* through the supply/demand effect -- so that one should actually resign one's job before saying one doubts it -- then surely the fact ought to be seen more clearly in the data than this, with more studies not finding an effect on rates than finding one!

Which is why Gale and Orszag change their ground to say it is *expectations of future deficits*, not current deficits, that affect interest rates, saying it is only studies that consider expectations that find an increase in rates -- and not the studies that look at the current deficit situation.

Yet it is only current deficits that have the described supply/demand effect in the market for bonds. Expectations can change current prices, certainly -- but without the government entering the market to buy even $1 of additional bonds, and thus no extra demand at all, one gets the result of expectations. While from the evidence of those studies above, even when the gov't does go borrowing in the bond market currently, absent the necessary expectations rates *don't* rise significantly due to the supply/demand effect.

So maybe it's not quite so *simple* as "the demand curve slopes down" so when the gov't borrows more rates must go up by a *significant* amount by supply/demand, and anyone who disagrees is professionally discredited, QED.

Posted by: Jim Glass on January 7, 2003 06:28 AM

"The argument that long-run deficits don't affect interest rates applies only to (a) a small economy that is (b) open to trade and capital flows and (c) possesses a fixed exchange rate."
Uhm!!! Ever hear the words "Ricardian Equivalence". Of course you did. Even if I think that most likely we live in world far away from Ricardian Equivalence, not even mentioning that possibility is, I am sorry to tell you, at least as dishonest intellectually as any statement Hubbard might have made. You should be more careful!

Posted by: Someone who reads Barro on January 7, 2003 06:30 AM

I read economics as a hobby.

I have no preference for Bush's economic policy,
if he can even be said to have a policy. I have
no opinion on Hubbard.

Brad is ignoring all sorts of debates among
economists. I don't think how many economists
participate in, or are even aware of, these
debates is relevant.

Some time ago, economists presented macro
general equilibrium models. They argued that
it did not matter if you thought of interest
rates as determined in the "market" for bonds
or the "market" for money. These two descriptions
are equivalent in this class of models.

Some economists (e.g., Nicky Kaldor, Basil Moore)
argue, though, that the supply of money is
not independent of the demand for money in the
institutional arrangements of advanced
capitalist economies. Demand for money causes
the monetary system to create the money
demanded. There is no independent supply. This
theory makes hay of Brad's argument.

Furthermore, Brad's supply and demand-based
reasoning seems to presume that the level
of income is fixed. I see no reason that
this objection should not apply to long
run models, as well as short run models.
This objection was raised by Keynes in
1936, on some readings. And many mainstream
economists have never really taken it in.
(If you think about what Brad is saying,
you see that he's rejecting Keynes for
long run theory.)

I think it matters to what happens what
Alan Greenspan and other actors believe.
Long run rates can be said to be merely a
complicated summing of short run rates over some
period. If Greenspan creditably signals
the Fed intends to keep short run rates
low over that period, why should long
run rate rises?

Last, we are not interested in increasing
investment as finance. We want increases in
plant. There may be a relationship between real
investment and the interest rate, among other
variables, but it is certainly as not as simple
as more bonds are supplied at a higher price
(lower interest rate). This is what the
Cambridge Capital Controversy investigated.
And it was shown that there's no reason to
think that more capital will necessarily be
wanted at a lower interest rate.

Posted by: Not An Economist on January 7, 2003 07:27 AM

>>But if it is really so *self evident* that rising deficits increase interest rates *significantly* through the supply/demand effect -- so that one should actually resign one's job before saying one doubts it<<

You miss the point. I would not be upset if Robert Barro were CEA chair and were saying that budget deficits don't significantly affect interest rates, because Barro would believe it.

I am upset when Hubbard says it, because Hubbard doesn't--and we all know that Hubbard doesn't.

Posted by: Brad DeLong on January 7, 2003 07:51 AM

That of course would depend on what you mean by the word "believe". It's macro, after all. A field of fads and few if any fixed principles. Ant don't forget that a rise in interest rates is NOT the same as a decline in welfare. Depends on things like what they do with the $. Now if Hubbard had come out and supported say the steel tarriff, then we would have a real problem.

Posted by: gerald garvey on January 7, 2003 08:01 AM

That of course would depend on what you mean by the word "believe". It's macro, after all. A field of fads and few if any fixed principles. Ant don't forget that a rise in interest rates is NOT the same as a decline in welfare. Depends on things like what they do with the $. Now if Hubbard had come out and supported say the steel tarriff, then we would have a real problem.

Posted by: gerald garvey on January 7, 2003 08:01 AM

That of course would depend on what you mean by the word "believe". It's macro, after all. A field of fads and few if any fixed principles. Ant don't forget that a rise in interest rates is NOT the same as a decline in welfare. Depends on things like what they do with the $. Now if Hubbard had come out and supported say the steel tarriff, then we would have a real problem.

Posted by: gerald garvey on January 7, 2003 08:02 AM

Dear Brad:
You are probably right stating that Hubbard's behavior is one of the cases of: "This is what I want to defend, let me take a look at theory and let's see how can I make a case for it". However, as economist, we should be careful about making statements regarding mental states instead of explaining observed behavior, that is after all our comparative advantage.
My previous point was that if the person that reads your first posting is someone that never went through first year grad macro he will get out of it that, except in some cases completely unrelated with the U.S. current situation, Hubbard's statements were just crazy.
Well the truth is that someone like Barro can make a serious intelectual case defending that position and that, in fact, it is much more difficult to find a link between long-run interest rates and deficits that we would like. The uninformed reader should be told that. It would be fair to add something like: "most empirical evidence does not support a strong version of the ricardian equivalence and there is at least a strong prior that long-run interest rates are related with deficits so I am not going to follow this line of reasoning further".
Summarizing one should decide if he wants to be an economist that talks to the general public or someone that talks to the general public and knows some economics.

Posted by: A reader of Barro, JPE 1974 and JME 1987 on January 7, 2003 08:18 AM

jimbo wrote:

>I was going to write upo something about "net"
>money creation, but then it occured to me that I
>had been missing something fundamental. Then it
>occured to me that you were missing it, too -
>and that meant that the economics profession as
>currently constituted was probably missing it.
>And that might be important.
...
>So let's assume things go as follows: A loans
>his $100 to B. (no interest, since to A, B's IOU
>is just as good as cash - he demands no risk
>premium) We now have $100 in cash, $100 in IOUs.
>If B then turns around and lends the same money
>to C, we still have $100 cash, but we now have
>$200 IOUs. And if C lends to D, we end up with
>$300 total in IOUs, but still only the same $100
>cash.

>But we don't have to stop there. We could keep
>recycling the same cash back through C, B, and
>A - in our 100% trust economy, there is no upper
>limit on how much "debt" can be created. Each
>player could be holding $50 billion in IOUs
>issued by the other players. The only limit is
>the ability and willingness of the players to
>take on new debt. (infinite, in our example).


I read this, and thought 'Kuwait Stock Exchange.' The unofficial stock market, Souk Al-Manakh, collapsed spectacularly and, I beleive, the situation was similar to the market you described. The market works great until person A wants to spend, say, $200 on food. People call in loan after loan, but all the IOUs can't change the fact that there are only $100 available.

Whatever the interest, whatever the risk, eventually somebody wants to spend all that money owed him.

Anyway, I don't remember (or ever knew) much about Souk Al-Manakh. If I remember right, people bought stocks with post-dated checks that they couldn't cover; the market grew and grew until enough people wanted to cash out; and... the money wasn't there; the market disappeared.

This seemed to have some more information:

http://islamic-finance.net/islamic-ethics/article-13/article13-2.html#n3

Posted by: Grayson Calhoun on January 7, 2003 08:46 AM

>>It would be fair to add something like: "most empirical evidence does not support a strong version of the ricardian equivalence and there is at least a strong prior that long-run interest rates are related with deficits so I am not going to follow this line of reasoning further".<<

I am looking forward to the times when in economics the ultimate yardstick for intellectual authority will be reality and not, as in pre-sciences, the other away around.

***

Am I not fully awaken yet or is there confusion here between aggregate demand and supply?

My own casual observations reveals to me that there is a contemporaneous relationship between deficits and long-term interest rates. There are complications, of course, as long-term interest rates are a reflection not only of current deficits but market participants' expectations regarding future fiscal and -to make matters further complicated- monetary policy. (You have by now noticed that I am more concerned with real world macro than general equilibrium theories.)

This contemporanous correlation between LT interest rates and deficits is what drives, via investment spending, the negative effect of deficits on aggregate supply. Deficits can help with aggregate demand. So, in the short-run, if aggregate demand falls short of aggregate supply, there can be room for deficit spending.

This doesn't mean that deficit spending is helpful for long-run growth, all the contrary. To make matters worse for the Bush Administration, the component of aggregate demand that needs the strongest boost in investment itself. So, I guess, crowding it out by boosting demand on other components of aggregate demand, is not only going to be inefficient in jump-starting the economy, but second, it's like kicking on a man lying sick on the ground (Mr. Investment Spending.)

Posted by: Jean-Philippe Stijns on January 7, 2003 09:01 AM

: You miss the point. I would not be upset if
: Robert Barro were CEA chair and were saying
: that budget deficits don't significantly affect
: interest rates, because Barro would believe it.

Brad, that doesn't sound quite right, because in your original blog, you said in part, "What an honest economic adviser would say is that a long-term deficit certainly does raise interest rates... and [there is] some good reason to think [the effect] is large." So, certainly a large part of your indignation (and political analysis) would be set aside if you thought Hubbard probably believed himself, but I assume you think that no honest economic adviser should merely dismiss the interest rate effect as "nonsense." [Caveat: we don't know exactly what Hubbard said in context.]

So, how much good reason is there to think that the effect is large?

Posted by: Mark Lindeman on January 7, 2003 09:06 AM

Grayson -

Precisely. Without interest, there is nothing holding back the expansion without limit. The point I was making was that the limits are not a function of the "supply and demand" of money vs. bonds. The "supply" is contrained only by how much debt people and firms are willing and able (or at least judged able by lenders) to take on. This is not the case for apples, or housepainters, or anything else you can model with a supply-and-demand framework. Interest rates are wither determined by central bank policy (short term) or by people's judgement about what central bank policy will be in the future (long term). It has nothing to do with how many bonds are outstanding.

If you still don't believe me, tell me this: what is the production cost of a bond? Does the marginal production cost ever go up?

Posted by: jimbo on January 7, 2003 09:19 AM

Well let's see here: The investment banker get his cut to sell, the rating company gets her cut to grade, the insurance company gets its cut to insure, the bond attorney gets a cut to opine, the trustee gets a cut to administer, there's a background report, maybe a couple of rainmakers here or there, some accountants to count .... and we get to do it all over again when we refinance.
Good thing the Fed doesn't need all the marginal costs, oops, Washington can do something cheaper than the states. Oh, and by the way, those 30 year tresuries I bought back in the early '80s with the high rates, oops, they can't refinance those, so tell me is that a marginal production cost? Good thing we're borrowing more at low rates to pay off the high.

Posted by: Wolfie on January 7, 2003 10:07 AM

To build on jimbo's (absolutely correct, imho) points:

Brad's argument depends on three linkages: federal deficits -> interest rate(s), interest rate(s) -> cost of capital actually faced by firms, and cost of capital -> investment.

The first *and* third are entirely unsupported empirically, the second is shaky.

Purely theoretical arguments like Brad's or Suresh's don't address the lack of empirical support. As jimbo says, the textbook may tell us that these effects exist, but not if they are large enough to matter.

Brad's dodge in his response to jimbo is his standard one when he's confronted on these points (check the MaxSpeak archives for other examples): he changes the subject from "higher federal deficits raise interest rates, thereby harming investment" to "higher federal deficits will provoke the Fed to raise interest rates." Not the same argument at all.

Posted by: JW Mason on January 7, 2003 10:23 AM

I think that many of the people responding to this critique of Glenn Hubbard are missing the fundamental point about what it means to be head of the CEA. As head, Hubbard should be ADVISING the president, not acting as a mouthpiece for the ideology of the White House. So when people bring forth stupid sound bites -- like deficits don't matter, they are Rubinomics -- or make stupid policy suggestions, it is Hubbard's responsibility to call the White House staff on it and suggest that, in fact, they may want to make their argument a bit more nuanced or pick something different. Hubbard is not doing the White House or himself any favors by saying things that contradict established economic principles and, more importantly, Hubbard's own views.

The White House has more than enough people who can go out and attack people like Rubin and the Clinton Administration for the policies of the late 1990s; HUBBARD DOES NOT HAVE TO BE ONE OF THEM.

Posted by: on January 7, 2003 11:14 AM

The lone Republican who is honest about Administration economic policy is Senator John McCain. The rest either care solely for the needs of the wealthiest or wish to tag happily along with power by serving with no murmur.

Posted by: on January 7, 2003 12:06 PM

Are the above commentators telling us that large deficits should be run at ALL phases of the business cycle -- or, since "deficits don't matter", that there is no harm in allowing them to expand indefinitely?

Also, check out Mickey Kaus' respose to DeLong for an exercise in truly Lewis Carrollian reasoning: " Meanwhile, mightn't there be a countervailing political virtue in using the prospect of long-run deficits to hold down government spending today -- so that when we (i.e., Democrats) inevitably raise taxes in the years ahead, a smaller portion of those taxes will have to go to paying for the existing government, and a larger portion can go for expanding government in new, worthwhile directions (such as universal health care)?" The fact that we could politically move funds from other government programs to the more "worthwhile" likes of "universal health care" just as easily right now if we chose, and that an era that has higher interest payments on the deficit will have less money for both "worthwhile" AND "non-worthwhile" government spending, seems not to have occurred to him.

Posted by: Bruce Moomaw on January 7, 2003 12:16 PM

I'll start worrying when the real interest rate on long-term bonds is greater than real economic growth for a significant period of time. until then - why fret?

Posted by: Ram Ahluwalia on January 7, 2003 12:27 PM

I subscribe to the notion that long-term federal deficits will cause the cost of money to rise thereby putting downward pressure on investments, but I'm wondering if there's an even bigger effect on long term rates from *how* the deficits are created. Isn't it true that blatant dishonesty creates distrust and doubt about the future which in turn causes capital to become more dear. Is it possible to quantify the effects of dishonesty from the top on long term rates and compare it to simple deficit spending? Has anyone attempted this already? I think the dishonesty is amplifying the negative effects of Bush's long run deficit plan.

Not an economist.

Posted by: dennis on January 7, 2003 12:31 PM

I don't even understand what Kaus is saying and don't care to take the time to figure it out. He's long since ceased to be an worthwhile read.

Posted by: Ian Welsh on January 7, 2003 12:38 PM

The post just above this one nicely gets away from the arcana of deficits and their relation to interest rates (however important) and back to Hubbard's behavior. DeLong has been closer to soemthing like Hubbard's job than any of the rest of us, I'd wager. He seems interested in what might motivate Hubbard to save his own economist's soul. I don't really have any idea about what might motivate Hubbard. I care more about the nature of his job and economic policy making. In my limited experience with those who have, or like to think they have, influence over economic policy (I occupied a dank corner of a congressman's office for a while) I had the impression that the influence of economists (or military planners, or sociologists) on policy was very often in the negative. Their only use in many cases is to stand up and say "that's worse than useless" when a politically advantageous plan is about to be put forward, costumed as good economic (or military or social) policy. Isn't the case against being a yes-man in advisory jobs more complete than just loss of influence? Isn't battle against the Karl Rove's of the world the overwhelming reason for tax payers to put up with the burden of paying the Hubbards of the world?

To be fair, I suppose a policy maker who is actually intellectually interested in economics (military planning, sociology) might benefit from being able to have a closed door discussion, confident that the details of the discussion would remain private. Beyond that, I stick by my suspicions till advised to the contrary by someone with greater experience in these matters.

Posted by: K Harris on January 7, 2003 12:38 PM

Interesting comments.

This Administration is remarkably united under the guise of changing the trust of economic policy since the New Deal. If it takes fierce deficits to create more and more of a rationale for slicing social welfare programs, then fine.

If it takes squeezing the middle class for the sake of giant money interests, then fine.

If it takes catering to giant money interests for the sake of holding office, then fine.

Undermine social service programs, play to the rich, undermine social service programs, play to the rich. Round and round.

Posted by: on January 7, 2003 12:53 PM

If deficits drive up inflation, how come the highly indebted Japanese have 0% rates?

And who is worried about rising interest rates? That is so remote from what is actually going on in the economy. The problem with the economy is not rising interest rates, the problem is deflation: China. The whole purpose of budget deficits is reflation.

Posted by: Daoud Nagitar on January 7, 2003 01:04 PM

Make that the 11.14 post.

Posted by: K Harris on January 7, 2003 01:18 PM

Daoud Nagitar writes:

"If deficits drive up inflation, how come the highly indebted Japanese have 0% rates?"

Deficits drive up long term interest rates, not (by themselves) inlfation.

"And who is worried about rising interest rates? That is so remote from what is actually going on in the economy."

I am worried about long term interest rates (and so is Brad DeLong, based on earlier posts). Real long-term interest rates have risen since Bush became president. That is what is actually going on and why I am worried.

Posted by: David Margolies on January 7, 2003 01:20 PM

"It's macro, after all. A field of fads and few if any fixed principles." [chortle]

Kudos to Jim Glass and "Not an Economist" for relieving me of some work. Jimbo's posts sound like a theory that is well-ventilated among incorrect economists -- what's called "endogenous money." To learn of this idea one must venture into the academic underworld of "post-keynesian economics," where respectable types like Brad and, until recently, Glenn Hubbard do not venture.

Posted by: Max Sawicky on January 7, 2003 01:21 PM

Did anybody read the paragraph under the * sign. This is what it is all about. Not about whether deficits raise interest rates (they do but probably not by much, and other factors mather as well), or by how much, or what it means but it is about a so called intelectual, a professor of econmics embarasing himself on TV saying they do not matter at all, calling it Rubinomics, when he has a book out there that has a FORMULA for calculating HOW MUCH they are increased. That is the point, and I am wondering where is "the liberal" press to point this out to him. And Brad knows when he says his reputation will be gone among economists, he is one of those that will never take Hubbard for serious again.

Posted by: on January 7, 2003 01:23 PM

Did anybody read the paragraph under the * sign. This is what it is all about. Not about whether deficits raise interest rates (they do but probably not by much, and other factors mather as well), or by how much, or what it means but it is about a so called intelectual, a professor of econmics embarasing himself on TV saying they do not matter at all, calling it Rubinomics, when he has a book out there that has a FORMULA for calculating HOW MUCH they are increased. That is the point, and I am wondering where is "the liberal" press to point this out to him. And Brad knows when he says his reputation will be gone among economists, he is one of those that will never take Hubbard for serious again.

Posted by: dan on January 7, 2003 01:24 PM

Amazing how daily contact with Karl Rove can potentially convince somebody of the intellectual truth of the value theory of Piero Sraffa...

:-)

But all this is beside the point: White House Media Affairs has now gotten Glenn's number, hence he is now useless in his job.


Brad DeLong

Posted by: Brad DeLong on January 7, 2003 01:25 PM

I see Max Sawicky just added a comment. In my comment (just before his) I satte that real long-term interest rates have risen, but provide no data. Max said the same thing in a post some weeks ago which I cannot find, but perhaps he could provide a link to. If not, take the long bond rate and subtract the current inflation rate for now and 1/1/2001.

Posted by: David Margolies on January 7, 2003 01:25 PM

Paul Krugman -

And instead of helping the needy, the Bush plan is almost ludicrously tilted toward the very, very well off. If you have stocks in a 401(k), your dividends are already tax-sheltered; this proposal gives big breaks only to people who have lots of stock outside their retirement accounts. More than half the benefits would go to people making more than $200,000 per year, a quarter to people making more than $1 million per year.

Posted by: on January 7, 2003 01:54 PM

Gale and Orszag make the important point that a reduction in economic growth is independent of an increase in the interest rate. Growth will be reduced as long as Ricardian equivalence does not hold. As an accounting identity, a decline in national saving (GNP-C-G) will reduce national investment (even if foreign investment compensates). Thus future GNP will be lower. (Future GDP may not be lower, if foreign investment fully compensates for reduced national investment -- the small open economy case; but future GNP always will be lower.)

Posted by: Wasow on January 7, 2003 02:16 PM

>>the small open economy case<<

But the United States is not a small open economy. Glenn Hubbard certainly doesn't think that the United States is a small open economy.

Posted by: Brad DeLong on January 7, 2003 02:28 PM

I'm under the impression that Hubbard's actual quote, as opposed to its paraphrase, is not that "deficits never raise interest rates", but "deficits at this level are insufficient to produce significant changes in interest rates" (I'm also paraphrasing), which is a very different proposition. Just as you, Brad, have been found defending not the silly proposition that increasing the minimum wage never causes job losses, but that raises at currently contemplated levels are insufficient to produce detectable changes in employment, it is entirely possible for Hubbard to believe both that deficits can cause higher interest rates and that these deficits won't. That's certainly arguable, but hardly dishonest.

Posted by: Jane Galt on January 7, 2003 02:31 PM

I find this more interesting than the interest rates contradiction:

He derides the "current fixation" with budget deficits, and labels as "nonsense" and "Rubinomics" the view espoused by former Clinton Treasury Secretary Robert Rubin that higher deficits lead to lower growth.

So a government shift of output from capital to consumption *doesn't* lower growth? Is Hubbard a big rational expectations fan?

Posted by: Jason McCullough on January 7, 2003 02:44 PM

Hubbard: "As an economist, I just don't buy that there's a link between swings in the budget deficit of the size we see in the United States and interest rates." (NYTimes, "Bush's Way Clear To Press Agenda For Economy," 11/11/02)

Posted by: Jason McCullough on January 7, 2003 02:54 PM

If deficits "didn't matter" under any circumstances, then obviously there'd be no point in the federal government ever raising any of its revenue through taxes at all. Over the business cycle as a whole, of course, they serve as a specialized form of "tax" -- and just as funding the government through deficits is better than raising actual taxes during the deflationary part of the business cycle, so it's worse than funding the government through raising actual taxes during the inflationary part.

But Hubbard -- in his Jan 4 letter to the Washington Post ( http://www.washingtonpost.com/wp-dyn/articles/A8389-2003Jan3.html ) that first alerted me to the Administration's new line -- makes no such qualification. He simply says, with no further elaboration at all: "We must keep in mind that growth leads to surpluses, not vice versa.". Which raises the question of whether these characters intend to continue trying to run huge deficits during the inflationary part of the cycle.

Meanwhile, consider Jonathan Chait's comments on Hubbard in the New Republic ( http://www.thenewrepublic.com/doc.mhtml?i=20030113&s=chait011303 ): "Hubbard argues that global capital markets have made deficits virtually irrelevant. If government borrowing soaks up capital that would otherwise be used by U.S. businesses, this line of thinking goes, then overseas investors will just take up the slack. 'Not surprisingly,' he told an audience last month, 'the evidence is that long-term interest rates do not move in lockstep with actual or expected federal budget changes.'

"But, while it's perfectly true that foreign investment can help cover for Washington's red ink, this doesn't make deficits any less bad. The ultimate problem with deficits is that they reduce the national savings rate, which is the proportion of our annual income that is not consumed. The savings rate is important because it measures Americans' ownership of productive assets--such as companies--that can produce future income. When the government runs deficits, it dips into the pool of money that would otherwise be used for buying productive assets and instead ties it up in financing government debt. Now, if you assume that foreign investors will replace every lost dollar, then interest rates won't rise, but that still does nothing for our savings rate. It simply means that companies that would have been producing future income for Americans will instead be producing future income for overseas investors. 'Instead of reducing the domestic capital stock," write William Gale and Peter Orszag of the Brookings Institution, 'budget deficits would represent a mortgage of the income from that capital, with the mortgage owned by foreigners.'

"So, even if Hubbard's argument were correct, it wouldn't mean that deficits don't harm the economy. It would only mean that long-term interest rates no longer reflect the level of harm they do."

Posted by: Bruce Moomaw on January 7, 2003 03:29 PM

I really don't think Professor DeLong should criticize others regarding the content of their textbooks. The first edition of DeLong's Macroeconomics text had so many errors that a new edition had to be published. Perhaps Professor DeLong's time would be better spent reviewing his own published work rather than the works of others.

Posted by: Neetin Gulati on January 7, 2003 03:55 PM

Pardon me, just what is being discussed here?

Prof DeLong seems to be saying about five different things.

First, that Glenn Hubbard said that 'deficits do not matter,' that is, they no deficit or series of deficits, of any size and any duration, has any effect on long-term economic growth.

In support of this point, we have an excerpt from a Wall Street Journal story in which Hubbard is quoted as saying "current fixation," "nonsense," and "Rubinomics." This is not enough to establish anything.

Second, DeLong says that Glenn Hubbard does not actually believe this.

In support of this point, we have a quote from Hubbard's text book that fully substantiates that he does not believe it.

Third, DeLong says that regardless of what Hubbard believes, it is not true.

This point is argued in several paragraphs, beginning with "You see, the claim that deficits matter . . ." and ending with ". . . and economic growth will slow." A qualification adds that the argument applies to "long-term deficits--those that last a decade or more," but not necessarily "short-term, stimulative deficits during a business cycle recession."

These arguments seem over simplified to me. Yes, deficits will, other things being equal, cause the interest rate to rise. But tax cuts will put more money into the hands of the people and businesses. Spending it will raise business income, and thus business income taxes. Investing it will tend to lower interest rates. How will these effects net out?

Even ignoring these complications, we are faced with some interesting questions: are we not in "a business cycle recession?" Will the Bush tax cuts bring on "short term, stimulative deficits?" Will the tax cuts cause "long-term deficits--those that last a decade or more?" There is no argument or discussion given to point us towards preferring any particular answer.

Also, I rather puzzled that at "03:25PM" on "January 07, 2003" [presumably, this should be January 6th, as otherwise the comments on the post were up before the post itself. Or does this mean the post was altered after its original appearance?] Prof. DeLong posts:

"What an honest economic adviser would say is that a long-term deficit certainly does raise interest rates, certainly does reduce investment, and certainly does put a drag on long-run economic growth. She would say that we really don't know how large the drag is, but that there is no good reason to think that it can be neglected as small, and some good reason to think it is large. She would say that that is what we know, that those are facts about our knowledge of the world, and that they need to be taken into account when White Houses devise economic policies."

While at "07:51 AM" he posts:

"I would not be upset if Robert Barro were CEA chair and were saying that budget deficits don't significantly affect interest rates, because Barro would believe it."

These would seem to contradict each other.

Fourth, DeLong says that Hubbard has made himself ineffective as an economic advisor to the President.

To support this, an argument is offered about the internal dynamics of the White House, beginning "Once White House Media Affairs knows that you have lied . . ." and ending "You can be counted on to prostitute yourself again. Thus you have no power."

Since it has not been shown what Hubbard said, or that it was a lie, or (more relevantly) that White House Media Affairs believes it to be a lie, the argument is moot.

Fifth, DeLong says that Glenn Hubbard is putting his academic reputation as an economist in jeopardy: "he will rapidly do severe, permanent, and irreparable harm to his standing within the community of economists, to his reputation, and to his own intellectual integrity."

This point depends on the first and fourth points being true, which is where the argument is weakest.

Absent better documentation of the first point, and any evidence at all on the fourth, I see no reason for Mr. Hubbard to take Prof. DeLong's advice.

Posted by: Stephen M. St. Onge on January 7, 2003 05:56 PM

The fact of the matter is that long term interest rates are up since the Bush presidency. The fact is also that this was predicted as happening when it became clear that Bush intended to run consistent deficits (though none of us realized just how staggering in size the deficits would be). Perhaps there is no correlation, but I'll tell you right now that the smart money has bet there is. Furthermore I find it amusing to watch so-called conservatives trying to argue that deficits are a good thing. Excuse me? You call yourself a conservative and you think that living beyond the government's means (and not just occasionally but for the forseeable future) is a good thing?

Mmmmm hmmm.

Posted by: Ian Welsh on January 7, 2003 06:54 PM

>>it is entirely possible for Hubbard to believe both that deficits can cause higher interest rates and that these deficits won't<<

Except that our swing in the deficit as a result of Bush Administration policies is no longer small--especially if you believe (as I do) that the Alternative Minimum Tax is going to be reformed sometime in the next five years.

Posted by: Brad DeLong on January 7, 2003 07:39 PM

Brad,

In your own comment (posted on 1-6-03, 10:09 PM), you state:

"If you want to think of a policy that (a) runs a deficit, and (b) has the central bank buy a lot of bonds for newly-printed cash, then I agree that things are different." Presumably, what you mean is that if increased defecits are accompanied by increased Fed buying of government securities, then interest rates will not rise, or will not rise as much as they would have in the absence of that kind of Fed intervention. I agree with that observation.

But then you go on to say, "But that's not what our Federal Reserve has done, is doing, or will do." This last statement has me utterly confused. The Federal Reserve's own website (www.federalreserve.gov/fomc/fundsrate.htm) states that "open market operations -- purchases and sales of U.S. Treasury and federal agency securities -- are the Federal Reserve's principal tool for implementing monetary policy."

Please explain what you meant by your "But that's..." statement, and in particular 1) whether you believe the Fed has not been controlling interest rates through open market activities, or will cease controlling interest rates in this fashion; and 2) whether you know with a high level of confidence that the Fed will not attempt to counter the effects of rising deficits with increased buying of government securities.

Posted by: Stefan on January 7, 2003 07:47 PM

Brad,

In your own comment (posted on 1-6-03, 10:09 PM), you state:

"If you want to think of a policy that (a) runs a deficit, and (b) has the central bank buy a lot of bonds for newly-printed cash, then I agree that things are different." Presumably, what you mean is that if increased defecits are accompanied by increased Fed buying of government securities, then interest rates will not rise, or will not rise as much as they would have in the absence of that kind of Fed intervention. I agree with that observation.

But then you go on to say, "But that's not what our Federal Reserve has done, is doing, or will do." This last statement has me utterly confused. The Federal Reserve's own website (www.federalreserve.gov/fomc/fundsrate.htm) states that "open market operations -- purchases and sales of U.S. Treasury and federal agency securities -- are the Federal Reserve's principal tool for implementing monetary policy."

Please explain what you meant by your "But that's..." statement, and in particular 1) whether you believe the Fed has not been controlling interest rates through open market activities, or will cease controlling interest rates in this fashion; and 2) whether you know with a high level of confidence that the Fed will not attempt to counter the effects of rising deficits with increased buying of government securities.

Posted by: Stefan on January 7, 2003 07:49 PM

Perhaps some conservative can explain to me the current intellectual justification for smaller government, given Prof. Hubbard's recent statements about deficits. If we don't have to worry about deficits, then why do we have to control spending?

Is the argument that government spending in some way distorts market outcomes? Suppose that is the case, is it okay then to spend all we want on non-distortionary activities where the market fails - childhood immunizations, prescription drugs for the elderly, lavish contributions to Jeff Sachs' global health fund, complete Federal funding of all failing elementary and middle schools, more homeless shelters and provide health insurance for all children? We don't have to raise taxes to pay for all this, we can just issue more bonds!!

And while they are at it, I would love to know answers to the following questions. Why do we have still have capital gains taxes? Why are we only reducing income tax rates by a few percentage points? Why not slash the low income brackets to zero (talk about lucky duckies indeed!) ? Why are state governments fretting about balooning deficits, why don't they just issue more bonds?

The answer to all this is of course that deficits matter, the question is how much they matter and when they start mattering. This has been pointed out by several readers of this forum who disagreed with Prof. De Long's initial posting. These readers have, to my mind, demonstrated far more intellectual honesty than Prof. Hubbard has. I would, however, hasten to point out to them that it is not Brad who needs to discuss the questions of "how much" and "when" but Glenn Hubbard. I would like to know how he determined $670 billion to be the "right" number that would not harm the economy in the long run. Could it have been $800 billion instead? In which case can we get the extra $130 billion to spend on the programs I mentioned above. Or is it that $500 billion was the right number but it is better to ask for $670 billion so that we get $500 billion.

The economics literature can offer us no definitve answer on the general impact of a deficit on interest rates. Presumably that is why we have the CEA, to do a careful analysis of the proposal, taking into account the current fiscal climate and provide the president with an informed judgment. My gut feeling is thatGale and Orszag studied this matter far more thoroughly than Hubbard did. I hope I am wrong.

Posted by: achilles on January 7, 2003 07:50 PM

Brad,

In your own comment (posted on 1-6-03, 10:09 PM), you state:

"If you want to think of a policy that (a) runs a deficit, and (b) has the central bank buy a lot of bonds for newly-printed cash, then I agree that things are different." Presumably, what you mean is that if increased defecits are accompanied by increased Fed buying of government securities, then interest rates will not rise, or will not rise as much as they would have in the absence of that kind of Fed intervention. I agree with that observation.

But then you go on to say, "But that's not what our Federal Reserve has done, is doing, or will do." This last statement has me utterly confused. The Federal Reserve's own website (www.federalreserve.gov/fomc/fundsrate.htm) states that "open market operations -- purchases and sales of U.S. Treasury and federal agency securities -- are the Federal Reserve's principal tool for implementing monetary policy."

Please explain what you meant by your "But that's..." statement, and in particular 1) whether you believe the Fed has not been controlling interest rates through open market activities, or will cease controlling interest rates in this fashion; and 2) whether you know with a high level of confidence that the Fed will not attempt to counter the effects of rising deficits with increased buying of government securities.

Posted by: Stefan on January 7, 2003 07:52 PM

I truly don't believe conservatives really want to run a deficit. I think it's entirely reasonable to suspect the real point is to put enormous pressure on elimination of social programs.

Furthermore, we're not talking just about "conservatives". We're talking about adherents to far-right, anti-government ideology.

Posted by: Jonathan on January 7, 2003 07:55 PM

I also don't believe Hubbard, or the Administration, really cares about the accuracy of their statements, or even internal consistency -- on several issues, administration spokespeople have given conflicting rationales for policies when prior reasons didn't go over well.

This is about selling policy based on ideology. Smaller government is good. It doesn't really matter how we get there, or even why it's a desirable goal.

Posted by: Jonathan on January 7, 2003 08:02 PM

>> Real long-term interest rates have risen since Bush became president.<<

and

>> The fact of the matter is that long term interest rates are up since the Bush presidency. <<

Data point....
Rates on 30-Year US Treasury Inflation-Indexed Bonds
11/2000: 3.85%
12/2002: 2.86%

http://research.stlouisfed.org/fred/data/irates/tp30a29

>>> The fact is also that this was predicted as happening when it became clear that Bush intended to run consistent deficits (though none of us realized just how staggering in size the deficits would be). Perhaps there is no correlation...<<

Well, no, not there, there isn't. As staggering as the deficits are, no doubt they are raising interest rates, other things being equal. It's just that other things are never equal, and it would seem the other things may be more important to interest rates than staggering deficits, if you believe the rates on US inflation-indexed bonds.

Posted by: Jim Glass on January 7, 2003 08:14 PM

Brad,

In your own comment (posted on 1-6-03, 10:09 PM), you state:

"If you want to think of a policy that (a) runs a deficit, and (b) has the central bank buy a lot of bonds for newly-printed cash, then I agree that things are different." Presumably, what you mean is that if rising deficits are accompanied by greater Fed purchases of government securities, then interest rates will not rise (or will not rise as much) as they would have in the absence of that kind of Fed intervention.

But then you go on to say, "But that's not what our Federal Reserve has done, is doing, or will do." This last statement has me utterly confused. The Federal Reserve's own website (www.federalreserve.gov/fomc/fundsrate.htm) states that "open market operations -- purchases and sales of U.S. Treasury and federal agency securities -- are the Federal Reserve's principal tool for implementing monetary policy."

Please explain exactly what you meant by your "But that's..." remark, and in particular 1) whether you believe the Fed has not been engaging in open market pruchases of government securities; and 2) whether you know with a high level of confidence that the Fed will not attempt to counter the effects of rising deficits with increased open market purchases.

Posted by: Stefan on January 7, 2003 08:16 PM

Brad,

In your own comment to the Hubbard piece (posted on 1-6-03, 10:09 PM), you state:

"If you want to think of a policy that (a) runs a deficit, and (b) has the central bank buy a lot of bonds for newly-printed cash, then I agree that things are different." Presumably, what you mean is that if increased deficits are accompanied by increased Fed purchases of government securities, then interest rates will not rise, or at least will not rise as much as they would have in the absence of that kind of Fed intervention. I agree with that observation.

But then you go on to say, "But that's not what our Federal Reserve has done, is doing, or will do." This last statement has me utterly confused. The Fed's own website (www.federalreserve.gov/fomc/fundsrate.htm) states that "open market operations -- purchases and sales of U.S. Treasury and federal agency securities -- are the Federal Reserve's principal tool for implementing monetary policy."

Please explain what you mean by your "But that's ..." statement, and in particular 1) whether you believe the Fed does not regularly engage in purchases and sales of Treasury securities; and 2) whether you know with a high level of confidence that the Fed will not attempt to counter the effects of rising deficits with increased buying of government securities.

Posted by: Stefan on January 7, 2003 08:26 PM

Sorry about the multiple posts of identical comments. My computer was telling me repeatedly that each attempt to post a message had "timed out," when in fact it had gone through

Posted by: Stefan on January 7, 2003 08:30 PM

Brad DeLong wrote:

>> Except that our swing in the deficit as a result of Bush Administration policies is no longer small--especially if you believe (as I do) that the Alternative Minimum Tax is going to be reformed sometime in the next five years. <<

The AMT will be "reformed" in a way that costs relatively little revenue while keeping the polticians secure and happy, one can bet on that.

For all the talk about how the AMT will sweep through the middle class in coming years, only a few elements of the AMT will affect a lot of people. Mainly its disallowance of dependency exemptions and the deduction for state and local taxes. The former produces little AMT revenue, and the latter produces little revenue from middle class non-investors.

So the politicians will be able to remove a lot of middle class people from the the AMT with a "reform" that does not do a lot more than allow dependency exemptions and a capped deduction for state and local taxes large enough to cover the average salaried person but not large enough to remove investors and "the rich" from the AMT's reach.

Thus the politicians will remove maximum numbers of would-be small-dollar AMT-paying voters from the AMT rolls at minumum revenue cost, while leaving the major revenue raising elements of the AMT intact.

Which will be too bad if one believes in the benefits of a broad tax base, low marginal tax rates, and/or a flat tax. If they'd just leave the damn AMT in place and unchanged, before too long we'd all be paying a flat 28% rate.

Posted by: Jim Glass on January 7, 2003 08:36 PM

>>you know with a high level of confidence that the Fed will not attempt to counter the effects of rising deficits with increased buying of government securities<

Yes. I am dead certain the Fed will not attempt to counter the effects of rising deficits with increased buying of government securities. Not a single governor nor a single regional Reserve Bank president would suggest such a policy.

Posted by: Brad DeLong on January 7, 2003 08:46 PM

>>Hubbard's actual quote, as opposed to its paraphrase, is not that "deficits never raise interest rates", but "deficits at this level are insufficient to produce significant changes in interest rates" (I'm also paraphrasing)<<

If you swing from a 2% of GDP surplus to a 1% of GDP deficit on the federal budget, that's a $300 billion swing in annual Federal demand--equal to one-quarter of the total amount of nonfinancial borrowing. It's a very weird market indeed in which a 25% increase in demand would have no significant effect on the price--and there's no reason to think that the U.S. bond market is such a weird market...

Posted by: Brad DeLong on January 7, 2003 09:13 PM

Brad,

How can you be so certain that the Fed will not step up its Open Market buying of government securities to stave off interest rate increases? I haven't looked at the Open Market Operations data, but isn't it likely that the Fed has increased its Open Market purchases in the past year? How else would interest rates have declined as deficits have risen (and as the expectation of growing deficits has intensified) during that period? And haven't Greenspan and Fed Governor Bernanke both indicated in recent speeches that they are more concerned about deflation than inflation, and that the Fed will do everything in its power to stave off the former?

Posted by: Stefan on January 7, 2003 09:22 PM

We'll see who has the last laugh on this. Yes 30 year treasuries are down as a flight to a supposed "safe haven" continue, but real long term corporate bond rates are up and so is the spread between corporates and treasuries. In other words, as old style conservatives would predict, there is less money available for private industry when the government is sucking it up. Is it the only cause/effect relationship in action? No. The most important one going on right now is (ever decreasing) bucket of money sloshing back and forth seeking returns in a lousy market and safety in the bond market. Investors are scared spitless by what has happened in equity markets and thus bond markets look good by comparison - especially US treasuries.

But the continuing dollar slide (which I expect to accelerate) is going to see treasury rates increase as well as there will be foreign flight. It'll be amusing to watch. Especially for those invested in the Euro and Euro denominated bonds.

Posted by: Ian Welsh on January 7, 2003 10:49 PM

The swing may be big, but the deficit is trivial as a proportion of either GDP or outstanding debt. I just don't see how you're going to get a huge effect on interest rates, and I just don't think you can honestly call Hubbard's position intellectually dishonest You may vehemently disagree with it, but it isn't indefensible. As far as I know, he has never promulgated the strong theory of the benefits of surpluses employed by the Clinton administration economists post-1994; disagreeing with it now is not hypocrisy.

And the last time I looked, most of the deficit was from the recession, not tax cuts. Are you arguing that we should be raising taxes or cutting spending in the middle of a recession?

Posted by: Jane Galt on January 8, 2003 05:25 AM

I'm an agnostic on this issue.

About Jim Glass's important datum (TIPS rates), aren't there other ways to try to calculate the long-term real rate? Something like 10-year Treasuries minus 3-month Treasuries?

From the same website that Glass got his data:

...............3-month......10-year
2000.11......5.72.........6.36
2002.12......4.03.........1.21

Note the yield curve inversion in Nov 2000.

By the way, what's up with the posting software? It takes a long long time for the posting window to acknowledge that the post went through (which is why sometimes people post repeatedly). (Hint: To see if the post went through, open up another window and click on the comments link.) I'm no software engineer, but I don't see why it has to take so long.

Best,

Posted by: Stephen J Fromm on January 8, 2003 06:16 AM

>>the strong theory of the benefits of surpluses employed by the Clinton administration economists post-1994<<

It's Marty Feldstein's theory...

Posted by: Brad DeLong on January 8, 2003 06:33 AM

>>And the last time I looked, most of the deficit was from the recession, not tax cuts. Are you arguing that we should be raising taxes or cutting spending in the middle of a recession?<<

Most of the deficit *this year* is because of the recession. The Bush plan is phased in over ten years (hence the tag "unstimulus"). Most of the deficit projection for ten years' time is because of the tax cuts. And the assumed effect on long term interest rates has much more to do with deficit expectations than with deficits today.

Posted by: dsquared on January 8, 2003 07:43 AM

Visit here for better take on what is really going on, link to Gross speech.

http://www.pimco.com/index.htm

Posted by: Daoud Nagitar on January 8, 2003 08:19 AM

That wasn't a slam, Brad; I'm certainly not going to try to argue the question of interest rates with you. ;-) But it was the signature economic talking point of the Clinton administration, and the fact that Glenn Hubbard does not agree with it does not automatically make him a hack, any more than Clinton economists were hacks for agreeing with it despite the widening deficits of his first two years in office.

Posted by: Jane Galt on January 8, 2003 08:30 AM

I truly don't believe conservatives really want to run a deficit. I think it's entirely reasonable to suspect the real point is to put enormous pressure on elimination of social programs.

Entirely correct. It's like David Stockman has risen from his grave, and is eating brains inside the beltway.....what? He's not dead?

Posted by: Jason McCullough on January 8, 2003 05:11 PM

It's fascinating to see how my visceral dislike of the field of macroeconomics as an undergraduate has returned in all its gorge-raising glory. Brad's denunciation is amazingly unfair and over the top, given the uncertainties about which mechanisms are right and what the relatvie magnitudes of those effects are.
My rule of thumb is that any discussion of monetary effects, including interest rates, is immediately suspect when we are discussing long-run growth. Using Brad's beloved potential vs. actual output distinction, the question of the long-run effect of the Bush plan is all about the growth of potential output and is better thought of in real, not financial terms, to the extent that is possible. Here Milton Friedman's wisdom is still apposite--the cost of government is the amount of government spending, and the financing arrangements are relatively unimportant. I would add the caveat that this point holds unless the government starts to run into default risk on the debt OR the tax rates rise enough to have important real effects on incentives. It seems blindingly obvious to me that the tax effects are a real issue today and the default issues are not, so a temporary run of deficits to stimulate more real output growth isn't so bad.

All that the deficit arguments are about is intergenerational public finance--should we pay for stuff now or let future generations take up some of the slack. Given that technological improvements likely to come in the next fifty years will make our descendants ridiculously more prosperous than we are (barring large-scale destruction from terrorists or other malefactors), I don't see that running some deficits now is so terrible.

I also wonder how anyone can seriously talk about "temporary" stimulus (meaning trying to close a gap between actual and potential output) when we know from both theory and empirics (don't ask me for the citation--remember my macro allergies) that only permanent changes to people's income gives a big swing in spending. Have they revoked Friedman's and Modigliani's Nobels recently?

Posted by: steven postrel on January 8, 2003 05:22 PM

Intellectual debates aside, I think your article highlights the dilemma for an economist working in the government. As I see it, that is the most important point of the article. At some point, I am going to talk about economics and macro policy making in my undergraduate macro class, I think your articile is excellent reading to illustrate why economists don't get to make macro policies and the reality of the politics involved. I think the students will appreciate it.

Posted by: Wei Kang on January 8, 2003 07:09 PM

Steven Postrel: "Given that technological improvements likely to come in the next fifty years will make our descendants ridiculously more prosperous than we are (barring large-scale destruction from terrorists or other malefactors), I don't see that running some deficits now is so terrible."

Well, shucks, given the fact that the technological improvements between 1925 and 1975 made us ridiculously more prosperous, I don't see that the Great Depression was so terrible. The real question is what effect Bush's plan will have over the next 10 years or so, and whether there are better alternatives. Milton Friedman's argument that it doesn't matter how you finance government spending -- quite apart from totally ignoring the effects of Keynesian demand-side stimulus -- also totally ignores the little matter of the pattern of income distribution.

Posted by: Bruce Moomaw on January 10, 2003 05:57 AM

Bruce: 1) Your Great Depression argument is misplaced. The issue (as Brad framed it) is not about macro stabilization policy. The complaint about tax cuts is that they supposedly reduce national saving and so reduce the growth of potential output. The Depression was about a gap between actual output and potential output, in conventional macro terms. That's not relevant to my point. Whether a dollar of spending today is paid out of today's consumption or tomorrow's consumption is the only issue at hand here.

2) The same applies to your comment about demand-side stimulus. But it seems funny that if you care about such stimulus you would be opposed to tax cuts per se, and especially to permanent ones which are the only ones that reliably increase the propensity to consume.

3) I don't care so much about the income distribution personally--such concerns are usually a poor disguise for envy and and an aesthetic distate for the spending habits of others, in my opinion--but I don't think the incidence of the corporate income tax, the effect of changing interest rates on income distribution, or any of the other distributional impacts beyond the direct ones are well enough understood to conclude anything about them. The one distributional issue that I did address was the intertemporal one, between us and our descendants, and I argued for the more egalitarian policy of making our incomparably richer descendants bear more of the burden of financing the preconditions for their own prosperity.

Posted by: steven postrel on January 10, 2003 02:16 PM

"I don't care so much about the income distribution personally--such concerns are usually a poor disguise for envy and and an aesthetic distate for the spending habits of others, in my opinion."

Interesting. Can I assume, then, that you have no objection to taxing the poor at a considerably higher rate of their incomes than the rich? And there is, of course, a fundamental moral difference between envy that is not morally justified and envy that IS morally justified; the latter is usually known as "a desire for justice". This, while obvious, is something libertarians tend to ignore whenever they talk about economics. But then, in my experience, when you scratch a libertarian you almost always find an Ayn Randian psychopath.

"The one distributional issue that I did address was the intertemporal one, between us and our descendants, and I argued for the more egalitarian policy of making our incomparably richer descendants bear more of the burden of financing the preconditions for their own prosperity."

Which will work splendidly if -- and only if -- the economy grows at a faster rate than the rate at which the deficit and its interest payments grow.

Posted by: Bruce Moomaw on January 10, 2003 06:24 PM

Probably superfluous rhetorical footnote: If the economy does NOT grow at least as fast as the deficit and the interest payments on it grow, then our "incomparably richer descendants" will have an even more incomparably gigantic debt to pay.

Posted by: Bruce Moomaw on January 11, 2003 07:31 AM

The complaint about tax cuts is that they supposedly reduce national saving and so reduce the growth of potential output.

No, that's the complaint about deficit-financed tax cuts. Tax cuts financed out of spending are just fine (though people may disagree with the spending cuts).

If deficit-financed tax cuts have no effect, they why do we bother collecting taxs at all?

Posted by: Jason McCullough on January 11, 2003 03:14 PM

This thread is getting so far down the page, i think I'm going to make this my last stab.

On income distribution: I mostly worry about the standard of living of the poor, not income equality. I'm not a maximin guy like Rawls, but I think the fixation on equality, in the US context, is destructive to the well-being of the poor as well as the rich. I don't quite get what the name-calling is for, since there isn't much of a peanut gallery to be influenced by your rhetoric, and it certainly isn't an effective way of persuading me. I also notice that you have no response to the problem of assessing the incidence of the corporate income tax.

On intertemporal equity: I see no reason to believe that these modest changes in public finance will cause the deficit or debt to explode, certainly not beyond the revolutionalry productivity increases that are likely to show up in the next few decades.

On tax cuts and deficits: Of course Jason is right that I should have specified tax cuts without equivalent spending cuts as the issue. But the substance of my analysis remains unchanged. We collect taxes instead of doing it all with bonds because there are default risks (which I mentioned in an earlier post).

Posted by: steven postrel on January 13, 2003 04:36 PM

Your call for Glenn Hubbard to step down from the CEA was actually a wonderful plea for integrity that all economists should read. I learned of it from reading a Bruce Bartlett criticism, but then Bartlett sacrificed his integrity many years ago.

Some e-mails have asked about Barro's reformulation of Ricardian Equivalance. Barro's ideas, however, have been highjacked by the "free lunch supply side" crowd such as Victor Canto and Robert O'Quinn (Joint Economic Committee staff). They claim that the Bush tax cuts will encourage more consumption but will not crowd-out investment. Barro, however, argued that unfunded tax cuts must be transitional and will not increase consumption. You correctly noted that the deficits don't matter crowd are trying to deny the laws of demand and supply. In truth, the free lunch crowd is doing even more than that because they are trying to deny the law of scarcity.

Posted by: Harold McClure on January 15, 2003 05:51 AM

I think your argument for standing by what you have previously written as an Academic is quite clear and succinct and a lot of these arguments (above) are a bit beside the point.

What strikes me as strange is how the Clinton Administration and the Fed managed to compromise and help the Economy along so well (at least until it became a bubble). I remember thinking that Clinton would fail miserably because his policies would be way too liberal for the Fed and Wall Street.

Now with the Fed and the White House in (more or less) the same ideological boat, the economy is completely floundering.

I don't know why, but it seems like it should be the opposite.

BTW - Interest rate here in Japan may be near zero but there is no liquidity. It is pretty tough for small businesses to get a loan. The companies doing well are the loan companies that charge something like >20% interest a year.

Posted by: Amused Reader on January 16, 2003 09:30 PM

Wow, you must be psychic! It looks like Hubbard is going to step down from his post.

Posted by: Amused Reader on January 23, 2003 01:13 AM
Post a comment
Name:


Email Address:


URL:


Comments:


Remember info?