Sunday, October 24, 2010

Romer: We must fix the defict....someday

Conventional macroeconomics failed spectacularly, yet the disciples of Keynes that got us in to this mess (or, at a minimum, failed to see it coming and scoffed, and continue to scoff, at those who did) refuse to go quietly sit in the corner while they try to figure out where they went wrong. To the contrary, they keep coming to us with solutions before they've even come to agreement on what caused the problem.

In such a fashion, we now have Christina Romer explaining to us why spending money we don't have is the best way to solve a crisis that was caused by spending money that we don't have. More to the point, she is pointing out how conventional macroeconomics (you know, because it worked so well last time) clearly explains that any attempts to reduce the deficit would clearly lead to a double dip.

Clearly, she has in mind the disaster that befell the American economy after the U.S. government literally fired millions of federal workers and slashed government spending in the second half of the 1940's. What? The economy rebounded after that? Oh. Well then, she probably means to illustrate how successful the deficit spending of Japan has been over the past 20 years in reviving that country's economy. What? That didn't work either?

Oh, here it is: The IMF says it's true!
"Some advocates of austerity argue that, contrary to the conventional view, fiscal tightening now would lower long-term interest rates and improve confidence so much that the impact could be positive. But an ambitious new study in the World Economic Outlook of the International Monetary Fund confirms that fiscal consolidations — that is, deliberate deficit reductions — typically reduce growth substantially."

First, "contrary to the conventional view" sounds like a good start. I'll keep saying it: the conventional view doesn't have too good of a track record.

Second, I know that the IMF is the first organization I go to when faced with questions of more or less government intervention in pretty much anything. I mean, it's not like an agency problem could exist or anything. I'm sure they'd be the first one to tell us if their prior decisions proved to be failures.

Still, I thought I'd take a glance at the report. This is what jumped out at me:
"Thus, whereas the usual strategy identifies periods of consolidation based on successful (cyclically adjusted) budget outcomes, our approach identifies episodes based on fiscal policy actions motivated by deficit reduction, irrespective of the outcomes."(see Chapter 3)

Catch that? Let me paraphrase: "the traditional approach to identify periods of austerity is based on identifying periods where governments actually spent less than they took in. The IMF’s approach identifies periods of austerity by identifying periods when politicians and bureaucrats publicly stated they were taking deficit reducing actions, even if those actions didn't actually reduce the defict."

That doesn't sound good. Christina Romer's version sounds much better:
It also breaks new ground by looking specifically at times when governments changed taxes or spending with the aim of reducing deficits. Previous studies looked at summary measures of the budget situation, and likely included cases when strong economic performance caused lower deficits, not the other way around.

But wait...she is still saying that the study throws out periods of deficit reductions cases accompanied by strong economic performance. Ummm...isn't that what we want? Not to mention the strategic use of the word "likely". I.e., maybe it did, maybe it didn't, but we threw them out just to be sure because if we didn't, deficit reductions come out looking better than we know they really are. This seems sketchy...back to the IMF report:
Methodologically,our approach is close to that of Romer and
Romer (1989, 2010)

Ah. Never mind. I can't exactly expect her to criticize her own methodology.

Romer's message in the New York Times is simply that deficit spending is the way out of the recession, and deficit reductions will either prolong or exacerbate the recession. Keep in mind two things, though: This Keynesian viewpoint, that capitalism should be "wisely managed" by really, really smart people (like Christina Romer) is what actually got us into this recession to begin with, and secondly, that for every PhD that feels the way Romer does, I can find one that disagrees.

The thing is, Romer may be right. I don't believe that she is, and her little OpEd is too flawed to convince me otherwise. I may suffer from confirmation bias, but I'm pretty sure that Christina Romer, who has built her career on the New Keynsian point of view, and the IMF, which survives off of funding from countries running large deficits, are just as susceptible to such biases as I am. And that's why I won't entrust to them my economic future and my economic decision making.

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