Economics Is Hard And Then You Die, Part II

Peter Coy at Businessweek:

Alberto Alesina is a new favorite of fiscal hawks like former President George W. Bush’s chief economic adviser, N. Gregory Mankiw. A professor of economics at Harvard University, the 53-year-old Italian disputes the need for more government spending to prop up growth and advocates spending cuts instead.

This is Alesina’s hour. In April in Madrid, he told the European Union’s economic and finance ministers that “large, credible, and decisive” spending cuts to reduce budget deficits have frequently been followed by economic growth. He backed his proposal with historical research on rich countries’ experiences since 1980. Later, at the Group of 20 summit in Toronto on June 26-27, the presidents and prime ministers of the advanced economies agreed to shrink their budget gaps by half or more by 2013. That put pressure on President Barack Obama to follow the lead of cost-cutters such as Britain’s Chancellor of the Exchequer, George Osborne, and German Chancellor Angela Merkel. Says Alesina: “I think the Germans are right.”

Alesina argues that austerity can stimulate economic growth by calming bond markets, which lowers interest rates and promotes investment. In addition, he says, deficit-cutting reassures taxpayers that more wrenching fiscal adjustments won’t be needed later. That revives their animal spirits and their spending. Alesina says that as a way to shrink deficits, spending cuts are better for growth than raising taxes. The Madrid paper, a summary of his views, was influential enough to be cited in the official communiqué of the EU finance ministers’ meeting.

The U.S.’s Rare Situation

Alesina’s historical research, though, doesn’t shed much light on what might happen if the U.S. adopts an austerity budget, because current circumstances don’t resemble most of those in Alesina’s database. It’s rare for a nation to suffer such a big shortfall in demand that it cuts interest rates to zero, as the U.S. has. It’s even rarer for a government in such circumstances to tighten its fiscal belt. Japan’s experience is a cautionary tale. Japan attempted to tackle its deficit in the late 1990s during a period of weak demand and near-zero rates. Many economists say the move prolonged the slump that became known as Japan’s Lost Decade. To be sure, Japan tried to balance its budget mainly by raising taxes, which is not Alesina’s preferred solution.

Economists who describe themselves as Keynesians or neo-Keynesians don’t buy Alesina’s medicine. Gauti B. Eggertsson, a staff economist at the Federal Reserve Bank of New York, concluded in a paper last November that, with interest rates at zero, the right remedy is to raise government spending, not cut it. Espousing his own views and not those of the Fed, Eggertsson wrote that when extremely loose monetary policy isn’t stimulative enough, “the goal of policy should be to increase aggregate demand—the overall level of spending in the economy.”

Alesina’s own research shows mixed results from deficit-cutting. He identified 26 examples since 1980 of deficit reductions that triggered growth of gross domestic product and 21 that lowered government debt substantially. He found only nine double victories in which government policymakers managed both to expand their economies and reduce debt. (Among them: Ireland in 2000, and the Netherlands and Norway in 2006).

Alesina is unfazed. While acknowledging that experience with zero-rate situations is scant, he says, “I don’t see how anyone can argue that we should push even more on the fiscal accelerator.” He says the greatest risk to global growth is a financial crisis brought on by fears of government overindebtedness. Clearly, economists are as divided as politicians. The problem is that if austerity budgets are pursued and they prove ill-advised, many more people will suffer than just a few economists.

Ezra Klein:

To argue with myself for a moment, this is one of the difficulties with analysis. Fairly few political commentators know enough to decide which research papers are methodologically convincing and which aren’t. So we often end up touting the papers that sound right, and the papers that sound right are, unsurprisingly, the ones that accord most closely with our view of the world. So Alesina’s paper gets a lot of conservative pickup, but if it had found the opposite, it would’ve been ignored by conservatives, or maybe torn apart by experts sympathetic to the conservative approach to austerity, even as liberals championed its findings.

That said, even as a matter of simple logic, I really don’t understand the case for why a business would begin spending if the government announces major cuts this year. So the government says, “I’m going to take demand out of the market, end tax cuts that are helping people spend, throw a large number of public employees out of work, and reduce the spending power of the unemployed.” And it’s in that context that, say, a manufacturer of picture frames, or a local coffee chain, decides to hire more people? Where is the promise of further demand?

Will Wilkinson:

This is one of the reasons I tend not to blog as much I’d like about a lot of debates in economic policy. I just don’t know who to trust, and I don’t trust myself enough to not just tout work that confirms my biases. This is also why I tend to worry a lot about methodology in my policy papers. How much can we trust happiness surveys? How exactly is inequality measured? How exactly is inflation measured? Does standard practice bias standard measurements in a particular direction? Of course, the motive to dig deeper is often suspicion of research you feel can’t really be right. But this is, I believe, an honorable motive, as long as one digs honestly. Indeed, I’m pretty sure motivated cognition, when constrained by sound epistemic norms, is one of the mainsprings of intellectual progress.

Anyway, I just wanted to say that Alberto Alesina was one of my favorite economists before Alberto Alesina was cool, and I don’t think his findings on deficit-reduction should be lightly dismissed.

Megan McArdle:

Wading through the online debates, I note that opinions on stimulus are nearly 100% correlated with the composition of that stimulus, and the opinionator’s prior view of that activity.  So when Democrats are in power and stimulus is mostly spending, liberals think that the stimulus is an issue of fierce moral urgency stymied by venal greed and rank idiocy, while conservatives develop deep qualms about budget deficits.  When Republicans are in power, and stimulus consists mostly of tax cuts, Democrats get all vaporish about deficits and the income deficit, while Republicans suddenly realize that the normal rules don’t apply in an emergency.  When out of power, both sides will grudgingly concede that some small amount of highly temporary stimulus might be all right, but note (correctly) that the other side seems to be trying to make permanent as much of this “stimulus” as possible.

For me, then, this mostly ends up as a proxy war over the level of government spending, a war I’d rather fight honestly on value grounds rather than attempting to disguise my preferences with a shoddy veneer of “scientific” logic.

E.D. Kain at The League:

This is one of my huge frustrations with blogging. I find that it’s very difficult to keep up with the paid professionals who have a great deal more time on their hands, more resources, and therefore better perspective and, generally, better material to show for it. Whatever expertise got them into those positions in the first place is given even more room to grow and evolve.

Sure, in the age of self-publishing anyone can blog and they can do it fairly cheaply. But unless you’re being paid well for your efforts or you’re independently wealthy, then you probably need to hold down another job or jobs, and that ties up a lot of time and energy and resources.

I don’t mean to complain by any means. I could have a much worse blogging set-up. But I do often find myself wishing that I had the time and resources at my fingertips that many A-list bloggers do. It’s tough to keep up.

In many senses I think this is all that really differentiates the really good A-list bloggers from everyone else. They have the time and the resources to burn on their writing, while the rest of us fit what we can into our busy days and hope it sticks. If it’s hard for Ezra Klein or Will Wilkinson to determine “which research papers are methodologically convincing and which aren’t” it’s even harder for the rest of us.

That’s my rant and I’m sticking to it.

UPDATE: Daniel Drezner

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1 Comment

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One response to “Economics Is Hard And Then You Die, Part II

  1. Pingback: What We’ve Built Today « Around The Sphere

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