Bob Cropf

Archive for February, 2009|Monthly archive page

Missouri’s stake in the stimulus

In Keynesianism, stimulus on February 28, 2009 at 12:26 PM

What Obama’s Economic Stimulus Package will mean for Missourians

Below is an article, which I just sent off to the St Louis Beacon, an online news publication.

Last month, Congress passed and President Obama signed into law a historic economic stimulus package that will spend $787 billion in the hopes of pulling the US out of the recession. The package has several parts. It will spend $260 billion over ten years to assist families with their taxes, buying a first-time home, paying college tuitions, extension of unemployment benefits and car purchases. More than $80 billion has been set aside to modernize infrastructure including transportation, federal buildings and water projects.Nearly $130 billion will be spent on expanding health care including boosting benefits for laid-off workers and to assist states with their Medicaid payments. Education receives more than $100 billion, with funds set aside for direct payments to local school districts and billions of dollars for school modernization, Pell Grants and special ed programs. The rest of the package is devoted to helping alternative energy production ($22 billion), investments in scientific research ($18 billion) and small business ($54 billion). These are all nationwide totals; what does the package mean for Missouri residents?

A new report issued by the non-partisan Missouri Budget Project estimates that the Economic Recovery Act will primarily help low- and middle-income Missouri families. The report also says the Act will help stimulate the state’s faltering economy.

The Missouri Budget Project’s analysis of the stimulus package has estimated that the state will recieve more than $4.3 billion over the next two years. This amount will be divided into three components: 1) state services, allocated by the Missouri General Assembly, 2) education, a direct transfer to local school districts, and 3) families, a direct subsidy to households hit hardest by the recession. Within each of these components, the spending stacks up this way:

1. State Services (more for health care including a Temporary Increase in the Federal Matching Rate in Medicaid, an increase in highway and public transit funding, more funds for the state to help pay for public safety, law enforcement, services for the elderly and the disabled, as well as money for Child Care services.)
2. Education (growth in spending on Title I, Education Block Grant funds and K-12 and Higher Ed funding)
3. Families (increases in Unemployment Insurance Benefits, funding for Emergency Shelters, and more money for Food Stamps.)

Not only will the billions in anticipated spending directly help Missouri families, the infusion of federal money into the state’s flagging economy will provide a much needed boost. As consumer spending dips, business profits drop off and state government revenues decline, which results in falling demand for goods and services starting the destructive cycle up again. Federal funds will produce a multiplier effect, in other words, for each new dollar invested in the state, a significant amount of new economic activity is expected.

Perhaps the best way to explain the multiplier effect of federal spending is to illustrate with an example. Imagine a currently unemployed construction worker who, as a result of the package’s infrastructure spending, is put back to work on a public transit project. With the wages earned, the worker can make a down payment on a new house, buy groceries and otherwise spend money that would go to stimulating the state’s economy, producing more jobs, more spending and more state revenues.

In sum, the Missouri Budget Project calculates that the multiplier effect will produce a $7.7 billion increase in the Gross State Product, will create 98,000 new jobs, and add $275 million to Missouri’s state revenues over the next two years.

Of course, in a plan of this magnitude there are always skeptics. The chief arguments against the package include more government spending will not end the recession and consumer, not government, spending is the way to get the economy back on track. In the case of the first one, critics assert that much of the government spending in the stimulus package will not have an immediate effect (e.g., infrastructure projects). Therefore, by the time money on these projects is spent, the economic recovery will be well underway. However, this argument assumes the typical long “start-up” times of most capital projects and ignores the fact that in many states there is already a back-log of “shovel ready” infrastructure projects, which have had to be shelved because of the states’ inability to finance them on their own and the recent federal cut-backs in funding. Furthermore, helping to rebuild the nation’s infrastructure, is a long over-due investment in our economic future. Not only does it generate new jobs by the millions, it also ensures economic growth in the years ahead.

The second argument assumes that the multiplier effect for government spending is less than one for privately-generated consumer demand. An example of this can be found in the following blog, Organizations and Markets , by four free-market economists. In a recent post, one of the authors says:

Of course, if GDP is adjusted for quality, the multipler [sic] is most likely negative, as resource allocation is directed by government officials, not consumer demands.

According to this perspective, only the production and consumption of iPods, cars, and similar private goods rather than public goods such as bridges, schools, roads, and libraries, results in “quality adjusted” GDP. Presumably, the author would take issue with Bureau of Economic Analysis of the U.S. Department of Commerce, which estimates additional economic activity that results from investments in different sectors in the $1.58 to $2.08 range. However, as the above quote indicates, free-market economics automatically discounts the possibility that public investments can have a positive effect even before the evidence is in.

It would certainly not be in the best interests of the state if the legislature were to follow the lead of the governors of some states and refuse federal money for some programs. Fortunately, Gov Jay Nixon shows every indication that he wants every federal dollar that the state is entitled to.


2010 Budget

In 1 on February 26, 2009 at 9:17 PM

The NYT has a brief article about the newly released 2010 budget.

There was something that caught my eye:

Before becoming Mr. Obama’s top economic adviser, Lawrence H. Summers liked to tell a hypothetical story to distill the trend. The increase in inequality, Mr. Summers would say, meant that each family in the bottom 80 percent of the income distribution was effectively sending a $10,000 check, every year, to the top 1 percent of earners.

Reminiscent of Okun’s Leaky Bucket, only I would bet that bucket isn’t that leaky… which has prompted another thought, what happens to the money “leaked” from said bucket. Borrowing from Stone, one person’s inefficiency could very well be another person’s job. So, that being said, the administrative costs of collecting money means employment for IRS agents, sales for computer companies, office suppliers, etc. How much of that actually gets funneled back into the pockets of the wealthy through those very mechanisms – computer sales, office supplies; and how much might actually continue to trickle down – a decent clerical or janitorial job for low-income, high school graduate or a secure stable job for a middle-income college graduate? Would the answers to these questions affect how much “leakiness” is deemed acceptable?


Why Keynesianism will (or will not) work

In Free-market, Keynesianism on February 26, 2009 at 1:20 PM

This article is a neo-classical take on Keynes. It presents the rationale behind why Keynes’ theory is supposed to work, which is the multiplier effect. In other words, federal spending for infrastructure and other things will result in additional GDP (an increase in the aggregate demand).

The article’s author does not believe this. He articulates a neo-classical response when he says that

Of course, if GDP is adjusted for quality, the multipler is most likely negative, as resource allocation is directed by government officials, not consumer demands.

I am not sure what he means by “quality” and, maybe if you read the article more closely than I, then something will immediately leap out at you. However, I believe it has to do with “consumer demands.” Again, we are faced with the issue that Galbraith raises, that is, can government produce wealth? Skeptics, such as classical economists, doubt this and so argue that only consumer demand can result in “quality” GDP. Presumably, this increase in aggregate demand would not come as the result of more bridges, roads and other public goods rather than increasing output of televisions and cars (i.e., what consumers want). Hence the author’s logic is that only private consumer goods will produce a true multiplier effect on the economy.

Why taxes aren’t so bad

In economics, public finance, statistics on February 25, 2009 at 5:59 AM

Ever since the Reagan administration, the American people have been bombarded with the unrelenting message that tax increases are unacceptable. The idea is that taxes hinder economic growth and sap the incentives of individuals and families to earn more because the government will just take it all away.

In the meantime, government spending continued to grow. Entitlements like Social Security and Medicare kept expanding as a result of demographics and increased benefits. The US embarked on an expensive military venture in Iraq and Afghanistan. So while taxes have been holding steady over the last three decades, spending has continued to grow. In the simple calculation of public finance, if spending grows and revenues from taxes remain flat then deficits have to grow. As we have seen, these deficits have been financed from borrowing–increasingly from countries with more robust rates of growth than ours. See the chart from the Times article cited below:

In today’s NY Times, Dave Leonhardt writes a thoughtful piece on the “upside of tax increases.” For many Americans bamboozled by years of being told we can pay for everything we need without raising taxes, his title might seem strange. However, as he points out, there is a fundamental law of economics, known as Wagner’s Law, which says that as society matures then taxes show a tendency to grow. This law was discovered in the 19th century and recent economic research confirms that it still operates.

Taxes, as Oliver Wendell Holmes, Jr., said are the price we pay for civilization. Without them, there would be no schools, highways, defense and many other things that make life worth living today. As a society, we have accepted half of the equation: The part that recognizes that we need those things to have a properly functioning society. But we seem to have forgotten or ignored the other half, the part that says that we have to sacrifice something to get what we want.

The bottom line is we cannot keep pushing off into the indefinite future paying for things we need today. By continuing to do this, we burden future generations and reduce their opportunities for economic advancement or we risk our creditors strangling our economy with higher interest rates as demand begins to outstrip supply of capital.

In miscellaneous on February 24, 2009 at 5:51 PM


Just a little humor as I sit here watching President Obama’s address to Congress.


In 1 on February 23, 2009 at 9:23 PM

I had to share this!

From DeLong

Is Social Security in danger?

In Social Security on February 22, 2009 at 2:01 PM

Two contrasting views on whether the Social Security program is in trouble. The first one is in the latest issue of the Regional Economist, an online publication of the Federal Reserve Bank of St. Louis. The article by staff economist, Michael Pakko, argues that the program is in need of reform as a result of the cumulative effects of climbing US debt, the growing deficit and “The retirement of the Baby Boom generation and a slowing rate of growth in the labor force will create a demographic time bomb in which entitlement growth threatens to swamp available resources.”

The second article is in the liberal newspaper, The Nation, entitled “Looting Social Security” by William Grider. Greider argues that the program is not in financial trouble as many critics claim. Instead, there is emerging, according to Grider, an attempt by 82-year old billionaire, Peter Peterson to undermine the government’s retirement program. Grider claims that Peterson’s

“most blatant distortion is lumping Social Security, which is self-funded and sound, with other entitlements like Medicare and Medicaid. Those programs do face financial crisis–not because the elderly and poor are greedily gaming the system but because the medical-industrial complex has the profit incentive to drive healthcare costs higher and higher. Healthcare reform can solve the financing problem only if it imposes cost controls on private players like the insurance and pharmaceutical industries.”

Two differing, recent perspectives on the fate of the Social Security system, a program that, no doubt, will come under increasing scrutiny in the months ahead in light of entitlements’ tremendous impact on the budget deficit.


Mortgage Crisis

In 1 on February 22, 2009 at 1:30 PM

After Freddie and Fannie were taken over last fall, followed shortly by the implosion of the entire credit market, it became “conventional wisdom” among some circles that Freddie and Fannie (and by extension the liberals in Congress who are lobbied by them) and the Community Reinvestment Act cause the financial meltdown. If the federal government has not forced lending to risky clientele (CRA) and artificially expanded the secondary mortgage market (Freddie and Fannie) none of this would have happened. Gordon covered this pretty well.

Well, Krugman, Thoma, and others have worked to debunk this and I have been reading a study using HMDA data from 2004. There was a very interesting set of tables (p. 20 & 22) that at least shoots some holes in that theory:

– %High priced (correlates with sub-prime) loans sold to GSE: 0.1%

– %High priced (correlates with sub-prime) loans sold to “Other Conduits”: 63.8%

– %High priced loans that are originated by CRA-regulated institutions: 16.1%

– %High priced loans that are originated by Independent Mortgage Bankers (e.g., Ameriquest): 83.4%

– %Low priced (correlates with prime) loans sold to GSE: 28.5%

– %Low priced (correlates with prime) loans sold to “Other Conduits”: 19.1%

– %Low priced (correlates with prime) loans originated by CRA-regulated institutions: 66.0%

– %Low priced loans that are originated by Independent Mortgage Bankers (e.g., Ameriquest): 26.2%

My understanding is that “Other Conduits” would include but is not limited to the MBS market where investment banks bought up mortgages, bundled and securitized them, then sold them. So this could be used to argue for “crowding out” – all that was left for other conduits was the sub-prime lot. OR since this market (for obvious reasons) was not very big prior to the early-2000s, it could be that this market was “artificially” expanded by the private sector due using the CHEAP money floating around.


DeLong and the Nature of Economics

In 1 on February 21, 2009 at 8:49 AM

I thought DeLong’s observations about the nature of economics especially vis-a-vis the current crisis is worth sharing:

Justin Fox Is Still Perplexed

He wonders:

Brad DeLong tutors me on fiscal stimulus :: The Curious Capitalist – I guess what continues to perplex me at least a little is how lacking in the customary rigor of modern academic economics the arguments for stimulus are. It’s basically just, We ran gigantic budget deficits during World War II and the economy got better. That’s the kind of argument I would make, not the kind of argument I’d expect from the chair of the Political Economy of Industrial Societies major at the University of California Berkeley. It’s just all so seat-of-the-pants. But it’s better to be approximately right than precisely wrong, I guess…

“Lacking in the customary rigor…” Justin could mean either of two things:

1. Rigorous economics should produce tightly-estimated conclusions based on statistical sieving of mountains of data, like: when Safeway cuts grocery prices by 1%, its sales rise by 1.456%.
2. Rigorous economics should involve lots of theoretical equations with sigmas and rhos and betas in them.

With respect to the first possibility, Justin’s expectations are just too high. We cannot build models up from precisely-known microfoundations–we are not chemists who can calculate how molecules should behave because we know how the electrons and the nucleons that make them up do behave. We don’t have that many past examples of large-scale fiscal stimulus programs, and so we do the best that we can–and to be up-front about the partial and uncertain state of our knowledge is part of doing the best that we can.

With respect to the second possibility–well yes, I could make a bunch of arguments with lots of theoretical equations with sigmas and rhos and betas in them, but once again these theoretical equations would not rest on any solid microfoundations. Chemistry theory is built on top of physics theory. But economic theory–it is just a bunch of people looking at historical episodes and saying: “it looks like this is what happened a bunch of times in the past; let’s build a model of it.” Economic theory is crystalized history. But when the historical episodes out of which theory is being crystalized are as rare and as scarce as they are in the case of large-scale fiscal stimulus programs, why crystalize? Why not just take the history raw?

– KC

Essay question #2

In 1, class stuff on February 21, 2009 at 7:43 AM

The answer to the second essay question is due on Wednesday March 11.

Essay Question #2

A key assumption underlying modern economic thought is that humanity behaves according to the rational actor model (e.g. homo economicus). Simply put, the term refers to economists’ theory that humanity is driven primarily by rational, self-interest (i.e., we respond to incentives and trade-offs). Use the rationality model to explain the causes of the current financial crisis.