Friday, September 11, 2009

Berkowitz and Fox’s Goler debate the relationship between deficits, stimulus programs and the country’s 9.7% unemployment rate w/ CEA Chair Romer

Yesterday’s report from the Obama Administration’s Council of Economic Advisers (“CEA”) argues that countries like the U. S. that spent more than others on stimulus programs are achieving better than expected levels and growth rates of Gross Domestic Product (“GDP”). Fox News Channel’s Wendell Goler asked CEA Chair Romer: If that is the case, why is the U. S. unemployment rate higher than the 8% that the Administration promoted to the country as the peak that would occur if the Congress enacted the 800 billion dollar stimulus program. [the current U. S. unemployment rate is 9.7%]

Chair Romer explains how 9.7% unemployment is a success story

CEA Chair Christina Romer responded to Fox's Goler at yesterday’s telephone press conference that while countries around the world were all hit by a “shock,” in terms of the collapse of our financial system, a lot of that shock was “concentrated in the United States and our recession in many ways has been much more severe here than in other countries.” Chair Romer said, “the crucial thing is what would have happened in the absence of the Administration’s stimulus and we certainly were on an even more downward trajectory than a lot of other countries.”

Romer essentially argued that the U. S. outperformed, relative to our respective baseline forecast, other countries with smaller stimulus programs. She also seemed to argue that the over-all decline in U. S. economic activity that occurred -- irrespective of the stimulus program-- was worst than expected, and that surprise accounts for U. S. unemployment exceeding 8%, even though Chair Romer thinks the stimulus program was successful in making that rate lower than it would have otherwise been.

Chair Romer says U. S. Unemployment rate to peak at 10%

Although not coming out of the CEA Report discussed yesterday, Chair Romer said that the Administration’s recently prepared economic assumptions for the mid-session review of the budget projects unemployment to peak in the U. S. at about 10% toward the end of this year or early next year—and she added that she thinks “that is a very reasonable expectation.”

Berkowitz debates "Rational Expectations," and Keynesian economics w/ CEA Chair Romer

Concluding the presser with the last question of about fifteen, or so, that were asked by assorted media on the conference call, this journalist sought to explore what Chair Romer thought was the impact of the recently revised upward CBO estimates of the federal deficits for the next decade, from seven trillion dollars to nine trillion dollars. Under “rational expectations,” theories, economists might think the impact of long-term deficits could be substantial, even in the short run. Investors know that deficits are likely to result, eventually, in higher tax liabilities on those making investments, resulting in lower expected rates of return, lower levels of investment and thus lower growth rates of GDP and higher unemployment.

MIT and UC, Berkeley v. Chicago School of Economics

Chair Romer, perhaps reflecting her academic pedigree (MIT) and teaching experience at University of California, Berkeley, didn’t buy into the rational expectations theories so much (which might be more popular at the University of Chicago economics department than at Berkeley or MIT). She seemed to follow the more traditional Keynesian economic theories that look at investment as a function of current interest rate or borrowing costs, with less of a focus on the consequences on investment of the anticipated higher taxes resulting from efforts to deal with the projected, massive U. S. budget deficits.

Deficits and Crowding Out

Romer did note the more traditional “crowding out,” theory of budget deficits. That is, when the federal government runs large deficits, the Treasury goes into the bond market to finance the deficits. Assuming the Federal Reserve does not step up to monetize the debt and buy the bonds from the Treasury, the sale of the bonds to individuals or private institutions will “crowd out,” private investments. This theory was used by many Democrats to criticize the large Reagan Administration deficits in the 80s. Chairman Romer seemed to argue that since interest rates are relatively low now, not much “crowding out,” is likely to occur for the foreseeable future.

You can take the boy or girl out of MIT but...

In short, the Chicago School of Economics argues that real world economics and business behavior are different from that predicted by the conventional Keynesian analyses presented by Chair Romer yesterday, and from that presented in the CEA’s paper prepared for Congress.[For a general discussion of the Chicago School of Economics, Milton Friedman and Price Theory,please go here ]. If we could get Chair Romer’s colleague, Austan Goolsbee, on “Public Affairs,” or Chair Romer on the show, we could perhaps explore some of these economic issues.

CEA member Goolsbee is on leave from the University of Chicago Booth Business School, so perhaps he is a part of the Chicago School of Economics. On the other hand, Goolsbee, like Romer, got his Ph. D. from MIT. And, although you can take the boy or girl out of the Keynesian MIT, you can't take the “Keynesian MIT approach," out of the boy or girl.
The transcript of the exchange between Chair Romer and your faithful correspondent is included, below:

Jeff Berkowitz: What’s the impact on the analysis you have done—I know it is not explicitly incorporated into it—of the revised expectations of deficits for the next decade from seven trillion dollars to nine trillion dollars (the estimate by the CBO). How does that factor in- in terms of looking at (because the President said last night how important it was not to add to the deficit when discussing healthcare insurance reform). So, with those large deficits over the next decade, nine trillion dollars, if you were looking at unemployment—the effect of your Recovery Act, with those larger deficits, what would you be looking at as a result of those deficits in terms of unemployment for next year, say, June of 2010?

Christina Romer, Chair, Council of Economic Advisers: I think the most important thing to realize is that in the short-run there is very little effect, or another way to say it-- why is it that certainly we and virtually every economist would say the right thing to do in a recession is to run a budget deficit—precisely because you know that’s a time when the economy is not producing at capacity and so actually needs the stimulus and so that certainly, you know, the President has never made apologies for running deficits now. It was something we needed to do. We needed to rescue the economy or the other way to say it, there is nothing that would be worse for the deficit than letting the economy go into free-fall. So, I think you do absolutely need to distinguish between the short-run and the long-fun and I think right now the government spending, the tax cuts are incredibly important, as our numbers suggest for helping the economy get out of this terrible recession and start growing again.

Where one worries about deficits is over the longer haul-that you fear that what it does is to raise interest rates, right, because the—usually we call it the “crowding out,” effect and that’s something of course that you have to be concerned about. We see no evidence of that happening now. Interest rates are at very low levels-- In part, because at a time of uncertainty, people find the United States a wonderful place and a very safe place to invest, but we’re absolutely committed to dealing with the deficit over the longer haul because we do think it can be a problem over the longer run and that’s why the President last night talked so about how important health care reform is because the number one thing that is going to make the deficit get big over the long haul is—get bigger—is our rising healthcare costs and we have also talked, you know the President has said he wants to cut the deficit that we inherited in half, put us on a trajectory for getting that thing down and we’re starting the 2011 budget process with exactly that in mind.

Jeff Berkowitz: But, if I may, Chairman Romer, don’t those large deficits, those expectations of large deficits deter investment now, even in the short-run, because investors look at those deficits as meaning higher tax rates, in one form or another, reducing the rates of return on those investments, so there is a short-run impact, isn’t there?

Chairman Romer: I think most economists would say there is not. And again, what we think people doing investment look at are things like the interest rate at which they are borrowing, they’re certainly—they’re looking at the Recovery Act and the fact that there are incentives for investment right now, like bonus depreciation, and I think one of the things we highlight in our report is the degree to which—if you say, what’s changed about GDP, what’s different? Well, in the first quarter [of 2009], fixed investment fell at 39%. And, in the second quarter, it still fell, but it fell at 11 %, right?

So, one of the things that we think we are exactly seeing is the investment sector turn around. That’s what the data on durable goods orders showed us. That is—shipments are up. Orders are up. All saying that people are actually saying, “It’s starting to look like a time to invest.” We’re even seeing residential construction turn up. Again, another kind of investment. So, I think when you look at what people are actually saying there-- is the sense of the idea that the economy is turning around and improved confidence. I think that’s incredibly important for investments, expectations-the sense that people want to start building things again in this country.
Telephone Press Conference with CEA Chair Christina Romer, September 10, 2009 (Emphasis supplied).