One of the powerful disciplines of science is the requirement that the validity of a theory is judged by how well it makes predictions. For example, the physical laws of motion are incredibly well validated by their ability to make very precise and accurate long-term predictions of the motion of the planets. The virtue of this discipline is that it allows theories to be both validated and refuted. This separates science from faith. Indeed, any well-constructed prediction ought to have clear measures of success or failure. Unfortunately, this discipline is difficult to apply to the social sciences. Nonetheless, difficulty in application does not render this approach useless.In January of 2009, a President Barack Obama economic team following predictions for unemployment both with and without the President’s stimulus package. The web site Innocent Bystanders has reproduced the Administration’s graph along with actual data from the Bureau of Labor Statistics. The graph is shown below:
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The key prediction was if the stimulus were not passed unemployment would peek at 9% while with the stimulus package the unemployment would not exceeded 8%. In actuality, the maximum unemployment peaked over 10% and has persisted much longer than predicted. According the the Administration, at this point we should have 7.5% unemployment rather than 9.9%. Most discouraging at this point, is that newest prediction of the Administration predicts unemployment lingering above 8% through 2012, falling at a slower rate than the Administration expected for unemployment with no stimulus package. One hopes that this prognostication will not be an under prediction.The facts above are not disputed, however their interpretation certainly is. Indeed, President Obama himself has said: “If the just say no crowd had won out..if we had done things the way they wanted to go, wed be in a deeper world of hurt than we are right now.”Consider the three possible outcomes of the stimulus package with respect to the unemployment predictions. If the unemployment rate dropped faster than predicted, then the President and his Administration would have justifiably crowed about their success. If the unemployment rate largely followed the original Obama Administration predictions, even with fairly broad margins of error, the Administration could have persuasively argued that their policies worked as expected. Now that the unemployment rate has soared past the original predictions, the Administration is arguing that the economy would have been worst had their been no stimulus package.The key thesis here is that regardless of the actual economic situation, the Administration supporters will argue that the stimulus package was beneficial. There is no possible outcome, (positive, neutral, or negative) that could, in their eyes, have demonstrated that the stimulus package has failed. The value of the stimulus has become a matter of faith separated from the facts. If you don’t agree with this conclusion, ask an Administration supporter, what set of economic facts would have been evidence that the stimulus did not work.
A Unique Economic Situation
Sunday, July 4th, 2010Economic analysis is complicated by the fact that controlled experiments are generally not possible. One cannot test different policy prescriptions on exact same economy and evaluate the different results. Arguments are made by analogy to previous circumstances. For this reason, it is difficult to conjure up a consensus among economists as to the best way to help the American economy recover from its current high unemployment and sluggishness.
There are two basic schools of thought: one that emphasizes monetary policy and one fiscal policy. Is the economy more or less responsive to controlling the money supply or federal taxation and spending, or some combination.
Milton Friedman won the Nobel prize in economics in 1976, for his explication of monetary policy and in part on his analysis of monetary policy during the Great Depression. Friedman argued that that collapse of the economy in the 1930s after its initial signs of trouble was caused the exact wrong policy followed by the central bank. The central back tightened rather than loosenes the money supply cause radical deflation and a lack of money available for investment.
The economist John Maynard Keynes is the champion of fiscal policy. Keynes has argued that federal deficits make up for demand in the private sector during recessions and provide a means for recovery. It should be noted deficits can be increased either by increased spending on reducing taxes
Since the banking crisis in 2008, the Federal Reserve has loosened the money supply about as much as it could. Perhap by this more than any other policy, the Federal Research helped avert a 1930s-like collapse in economic activity. At this point, however, the Federal Research has exhausted much of its ammunition. Interests rates are at historic lows. Monetary policy has helped, but all the Federal Reserve can do now is maintain a loose monetary policy until a strong recovery commenses.
In February 2009, after the immediate banking crisis had abated, the Obama Administration passed its stimulus package with nearly a trillion dollars of deficit spending. Results have been at best mixed. Growth remains anemic and unemployment and under employment remain much higher than the Obama Administration promised. Nobel-prize winning economist and NY Times columnist, Paul Krugman, recently argued that given the lack of economic response, we need to re-double fiscal stimulus. We note in passing that Krugman always argues from more governement spending and not reduced taxes. Either would increase the fiscal stimulus.
We submit the thesis here, that additional fiscal stimulus now would be ineffective because of collective physcology. Given the massive deficits we have already incurred, people will become more apprehensive about the future and hoard cash if the deficit increases much more. The problem was that the Obama stimulus was accompanied with health care changes and progressive agenda that promised not a one-time fiscal punch, but a fiscal trajectory that would incur even greater deficits or significant tax increases. In the face of this uncertainity, people are saving more. in anticipation of future bad times. Ironically, this fear is suppressing consumer demand. Business, also faced with uncertainty, sits greater than average cash reserves.
By creating what seemed to be a permanent and expontenially expanding deficit, rather than a short-term stimulus, the Obama Administration undermined the effectiveness of its signature economic policy. At this point, the best that can done is to reduce uncertainity by maintaining the current tax code and creating an economic plan that restrains federal spending. In any case, it will take a long time to dig out of the current situation, but if certainty returns, businesses will be more willing to invest their acccumulations of cash and consumers wil be more willing to spend some of their savings.
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