Taylor v. Krugman, Round 2

Paul Krugman (click through to see Krugman’s corresponding charts):

Via Brad DeLong, I see that John Taylor is peddling the zombie claim that there has been a huge expansion in the federal government under Obama.

Sigh.

[…]

In answer, the peddlers of this myth point to the fact — which is true — that federal spending as a share of GDP has risen, from 19.6 percent in fiscal 2007 to 23.6 percent in fiscal 2010. (I use 2007 here as the last pre-Great Recession year). But what’s behind that rise?

A large part of it is a slowdown in GDP rather than an accelerated rise in government spending. Nominal GDP rose at an annual rate of 5.1 percent from 2000 to 2007; it only rose at a 1.7 percent rate from 2007 to 2010. How much would the ratio of spending to GDP have gone up if spending had stayed the same, but there had not been a slowdown?

…about half of the rise in the ratio is due to a fall in the denominator rather than a rise in the numerator.

That still leaves a significant rise in spending. What’s that about?

[…]

“Income security” is unemployment insurance, food stamps, SSI, refundable tax credits — in short, the social safety net. Medicaid is a means-tested program that also serves as part of the safety net. Yes, spending in these areas has surged — because the economy is depressed, and lots of people are unemployed.

What we’re seeing isn’t some drastic expansion of Big Government; we’re seeing the government we already had, responding to a terrible economic slump.

John Taylor subsequently defends his op-ed in the Wall Street Journal, the point of which was to demonstrate the the budget presented by the president sought to make this increase permanent:

Krugman is wrong. The Administration’s budget did propose spending levels which make the recently increased rate of government spending as a share of GDP permanent, regardless of the reason for the recent increase. If you want to see this in a way that takes account of changes in nominal GDP growth related to the recession, then you can compare actual spending before the effects of the recession began with proposed spending after the effects of the recession are over. For all of 2007, spending was 19.6 percent of GDP. For all of 2021—after the impacts of the recession and the final year of the budget window—the budget submitted in February proposed spending equal to 24.2 percent of GDP. These two budget facts are part of the data presented in my Wall Street Journal chart and are taken directly from CBO tables. The 4.6 percentage point increase represents $1 trillion more federal spending per year at 2021 levels of GDP.

The emphasis is mine.

I will let readers be the judge of who is being partisan.

Williamson to the Rescue

Steven Landsburg posted something last week on the “idle” rich and tax incidence. Bizarrely, it drew a great deal of attention in the blogosphere for supposedly being “obviously wrong.” Luckily, Stephen Williamson has written an excellent post explaining the principle of the argument as well as why these types of questions (and the corresponding answers) are important to think about.

Straw Man of the Day

[These school districts] believe that equity in education is essential and that all children, regardless of economic circumstances, should receive an excellent education.

That is Randi Weingarten, president of the AFT, in the WSJ writing presumably this in juxtaposition with free market reformers alluded to earlier in the op-ed. I found this statement to be rather odd considering that fact that I favor both reforms to increase education in schools and believe that all students should be able to receive an excellent education. However, I recognize — apparently unlike the AFT president — that the current school system and, in particular, the nature in which school districts are funded do NOT enable all students to get an excellent education.

Beyond the straw man (there were actually many to choose from within the article), Weingarten defends public schools through attacks on charter schools, citing the Stanford study that shows that only 17% of charter schools showed improvement over their public school counterparts, 37% performed worse, and the remaining 46% perform about the same. Weingarten cites this as unequivocal evidence that charter schools are a waste of resources. However, these statistics are far from meaningful for three reasons.

First, the funding for charter schools is generally based in part on per pupil funding in the existing public schools. However, charter schools typically receive less funding than do traditional public schools. As such, an advocate of charter schools could use the exact same statistics to argue that 63% of charter schools perform as good or better than public schools at a lower cost.

Second, there is a large degree of heterogeneity across charter schools in different states and across the different schools themselves. As a result, the observations generated across schools could help to determine what works and what does not.

Third, and finally, I mostly do not care about aggregate results. My main concern is whether the individual students are better off than they were in the public school system. This is distinctly hard to measure given the absence of a counter-factual. However, one rather simple (simplistic?) way to analyze parent satisfaction with the charter schools. For example, one could determine whether or not the student is better off by looking at the enrollment patterns in the schools to determine whether parents move their children back to public schools or if there are trends in enrollment toward (or away from) charter schools. These methods, of course, are not perfect. There could be some type of educational policy equivalent of money illusion. However, this would likely tell us more than the aggregate data.

Default or Inflation?

Over the last year or so there has been an increasing amount of discussion about government debt, default, and monetary policy. For example, and I plead guilty to this as well, a number of people have remarked that Greece’s debt problem is made worse by the fact that they do not have their own currency. However, I have come to realize that I have a distinctly different view on this issue than others who make similar claims.

What I have in mind in talking about the importance of a country having its own currency is the sovereignty over monetary policy. Suppose that government debt and nominal income are both increasing, but the ratio between the two is not. Now suppose that one does not have sovereignty over monetary policy and that policy becomes tight without any change in fiscal policy. As a result, nominal income declines. To the extent that tax revenue is raised through income taxes, this implies a corresponding reduction in revenue and a larger budget deficit than initially planned. The larger budget deficit means a larger increase in the stock of government debt. The larger government debt coupled with lower nominal income causes the ratio between the two to get larger. Since this is a crude measure of the country’s capacity to pay back the debt, this change is potentially significant.

Now it is important to note here that I am not arguing that monetary policy should be used to adjust nominal income such that the ratio of government debt to nominal income remains unchanged or even reduced. Rather, what I am attempting to illustrate is that if monetary policy is responding to the nominal income (or inflation) in France or Germany, tighter policy will reduce nominal income in the periphery as well. In other words, the lack of sovereignty over monetary policy can potentially increase the debt-to-GDP ratio or force fiscal policy to effectively respond to changes in economic conditions of the surrounding Euro area. This has important implications for a country’s capacity to pay back their debt and therefore the potential for default.

The view that I put forth is not revolutionary. It is widely recognized in discussions of optimal currency areas. However, it seems that many (if not most) of the others that I see emphasizing the importance of a domestic currency and/or sovereign monetary policy are espousing a completely different view. Specifically, it seems that are a number of folks who suggest that it is impossible for the government to default on debt if it is denominated in the domestic currency. This is not the view that I put forth and it is not entirely clear to me that (1) this is true, or (2) that this would somehow be more beneficial than a default.

On this note, Megan McArdle has a pretty good round-up of some of these points. For example, regarding (1) she writes:

It isn’t even technically true–Zimbabwe eventually ran out of hard currency to buy the ink it needed to print the money to sustain its hyperinflation.

In addition, regarding point (2):

To be clear, I do not think that a classical default*, with or without hyperinflation, is very likely. But that is not the same thing as saying that it is impossible. Moreover, the dismissive way that Galbraith treats this problem looks only at the stock of debt, not the flow of funds. Inflation is only a good way to get out of your debts if you aren’t planning to borrow any more money.

[…]

But what I find most disturbing about Galbraith’s formulation is that it seems to imply that inflation is somehow a less worrying solution to the problem of debt than default is. But inflation merely redistributes the pain; it doesn’t really eliminate it. You can argue that a small amount of inflation is preferable to the alternatives, distributing the pain very broadly in order to avoid the intense dislocations of a sudden shock. I might even agree with someone who argued this. But small amounts of inflation are not going to rid us of $10 trillion in debt. And the pain of large amounts of inflation is extremely painful–arguably, more so, not less so, than technical default.

My only area of disagreement — and I am not even sure based on the context the extent to which we disagree — is in regards to the actual costs of inflation. I think that even modest inflation is going to be very costly and that even many economists ignore the full costs associated with inflation (see Leijonhufvud and Horwitz). Lago and Wright, for example, argue that the benefit of a reduction of inflation from 10 percent to 0 percent is worth 3 – 5% of consumption.

The takeaway from all of this is that sovereignty over monetary policy is important for government debt. While the ability to pay off the debt using newly created money renders default unlikely, if not impossible, it is far from clear that this solution would be any less costly.

The Prescience of David Laidler

Though it’s not quite the same issue, and though I’m an outsider who may be missing something, it’s considerations like this that make me still rather uneasy about the future of the Euro. A common currency is more than just a limiting case of a fixed exchange rate, of course, but I really do wonder whether European institutions are well enough developed to manage the politics of monetary policy, and particularly its interaction with fiscal policy, within the Euro system.

That is David Laider in an interview from his festschrift.

Quote of the Day

Paul Krugman responded to my reply (March 31) to his two critiques (afternoon and eveningof March 30) of my post (January 14) on the negative correlation between investment and unemployment. He now says that Taylor “professes himself baffled.” Of course I didn’t profess any such thing. I simply showed that Krugman was wrong.

That is John Taylor in the latest update in a series of back-and-forth posts on the relationship between investment and unemployment. The posts are worth reading. In addition, check out this post by Hashmat Khan on this same relationship and some evidence on which way causality is running.

The Most Startling Sentence I Read Today

Here’s my bottom line: after we get through spending our $1 trillion under ObamaCare, there is no convincing reason to believe that the bottom half of the income distribution will have more care, better care, or better access to care than they have today.

That’s John Goodman on health care reform. Read the whole thing.