Thursday, November 18, 2010

I thought Martin Feldstein had a brain.

As Dean Baker put it recently, “In elite Washington circles ignorance is a credential.”

This credential is clearly possessed by Greg Mankiw, Rogoff, and others. But till now, I thought Martin Feldstein was free of this dubious credential. Unfortunately a recent article of his in the Wall Street Journal casts doubt on the latter idea.

Feldstein’s first paragraph reads “The stubbornly high unemployment rate is our economy's top problem today, but our exploding national debt is the more serious problem for the future. The recent proposal by Erskine Bowles and Alan Simpson, the chairmen of the bipartisan National Commission on Fiscal Responsibility and Reform, shows how difficult it will be to cut deficits and slow the growth of the national debt.”

First, anyone who takes Bowles and Simpson seriously, has to be economically illiterate, for reasons I spelled out here.

Secondly, why is it so difficult to “cut deficits and slow the growth of the national debt”? Feldstein doesn’t explain. The reality is that a deficit can accumulate EITHER as additional national or debt OR additional monetary base (which is to some extent what has actually happened over the last two years or so, and is what Keynes recommended).

In other words it is perfectly feasible to continue with the deficit and have NO rise in the national debt as a consequence. Got that? I’ll repeat that (in bold and in colour) just to drive the point home.

It is perfectly feasible to continue with the deficit and have NO rise in the national debt as a consequence.

Of course, the “monetary base” option is doubtless more stimulatory, dollar for dollar, (and potentially inflationary) than the national debt option. But what of it? If you use a higher energy fuel in a car engine, but want constant power output, what do you do? The answer is use less fuel. Doh!

Feldstein then trots out the old Ricardian myth that “the mere prospect of persistent high deficits jeopardizes the current recovery by creating the expectation that tax and interest rates will eventually rise substantially.”

The idea that the average household knows what the deficit per household is an idea straight out of la-la land. And the idea that the average household then “saves up” so as to meet the future alleged tax liability is also straight out of la-la land. Moreover, the evidence just does not support this Ricardian idea. That is, the average household does exactly what anyone with an ounce of common sense expects them to do. I.e. given increased income (as a result of a deficit), the average household SPENDS a significant proportion of that increased income in a fairly short space of time, and saves a proportion (and not for the most part to meet some carefully calculated future tax liability).

For the evidence, see here, here, here and here.

Apart from the empirical evidence, there is a whapping great theoretical flaw in the idea that it makes sense for any household to “save up” to meet the alleged future tax liabilities resulting from a deficit plus increased national debt. It’s thus.

The motive for this saving is presumably that the alleged future tax liability will reduce living standards for households, and to mitigate this, households save (i.e.sacrifice living standards NOW) so that they can spend a bit more (or maintain living standards) when the alleged extra tax becomes due.

Now let’s suppose, just to keep things simple, that a deficit has to be run THIS year to maintain full employment, and that NEXT year government has to raise taxes to prevent the economy overheating (while employment stays at the “full” level). Let’s also assume to keep things even more simple (and for the benefit of the simple souls who believe in Ricardian equivalence) that we have constant technology and a constant population.

In this circumstance, living standards or income per household will be EXACTLY THE SAME in each year! There is absolutely NO POINT in households “saving up” to meet the tax liability in the second year. Put another (and figurative) way, the income that government grabs from households in the second year, is income that those households COULD NOT SPEND IT THEY WANTED TO, without causing excess inflation!

It’s a bit like each household having $2,000 worth of obviously forged $10 bills: no use to anyone. They can just be removed from each household and burned.

In short (and this is admittedly a bit far fetched), perhaps the reason why households do NOT save much so as to meet the above alleged future tax liability is that the average household is more clued up than people like Martin Feldstein who teach economics at Harvard!!!!

Cynical conclusion.

It is of course possible that Feldstein is only acting the idiot. When the king is an idiot and is surrounded by idiots, it is necessary to play idiot to be heard at court.

Afterthought (5th May 2011): On the subject of Feldstein's deficiencies, I see someone agrees.


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