This morning former director of the Office of Management and Budget in the Obama Administration Peter Orszag’s op-ed at Bloomberg on automatic stabilizers caught my eye:
According to early forecasts, the U.S. economy should already have recovered from the financial crisis. Despite some recent encouraging news, though, we still don’t know when things will be back to normal.
What have we learned from this delay? That in devising public policy to respond to the recession, it would have been smart to minimize the guesswork by relying more on automatic economic stabilizers.
This lesson is immediately applicable: Rather than simply extend the payroll-tax holiday for the rest of the year, Congress should link it to the unemployment rate.
Automatic stabilizers are components of the budget that cushion the blow from an economic decline, without the need for emergency congressional action. For example, when the economy weakens, tax revenue falls and certain forms of spending — such as unemployment insurance — automatically increase. The net result is to attenuate the impact of a recession, by providing stimulus right when it’s needed. As the economy recovers, the stabilizers recede, mitigating the longer-term effect on the budget deficit.
What’s crucial is that, once the automatic stabilizers are put in place, they do the work. They remove the need both to guess about the economy and to overcome legislative inertia.
In general I’m in favor of rules-based systems. The U. S. Constitution is, or at least used to be, such a rules-based system. A government of laws and not of men in John Adams’s phrase provides automatic political stabilizers against the foibles, agendas, errors, and ideologies of individual human beings.
However, a problem arises in his example:
So now imagine if more of the 2009 Recovery Act had been in the form of automatic stabilizers — provisions linked to the unemployment rate — rather than predetermined to fit a shorter and less severe decline than we have experienced. About two- thirds of the 2009 Recovery Act took the form of tax cuts, temporary relief to state governments, food assistance to the poor, and additional unemployment compensation. And all these provisions were set to end within a year or two.
Imagine, instead, that they had been written to remain in full effect as long as the unemployment rate was higher than, say, 7.5 percent, and then to phase out gradually below that threshold. In January 2009, the CBO would still have assigned a very low cost to such an approach for 2012, because its projections assumed a much lower jobless rate. (The budget office would have shown some modest cost to reflect the probability that unemployment would stay above the threshold.)
There is no direct way to measure the unemployment rate. Consequently, there are many, competing ways of calculating it that produce different results. The unemployment rate is, therefore, analysis rather than data. The same is true, BTW, of gross domestic product and the rate of inflation.
More automatic stabilizers based on analysis will not necessarily produce better results. It will merely move the action from the elected representatives of the people or the elected executive and his aides to economic analysts. Economic analysts, too, are human begins with preferences, agendas, prejudices, foibles, and who make errors.
If an economic analyst, armed with knowledge of his field and of his colleagues, comes to me with the plea to limit and reduce the power of economic analysts, I sit up and take notice. When he or she comes to me pointing to the advantages of giving him or her more power, I’m skeptical. Why are there so many people who believe that if only they were given more power to enforce their preferred programs over the disagreements of their opponents, that all would be well?
As information and communications technology improve we will have more and more data and more and more things that are now the products of economic analysis will actually be measurable. So, for example, the Billion Price Project is a step in the direction of real-time direct measurement of prices and inflation. Someday it may be possible to measure inflation, unemployment, and gross domestic product directly. When and if that happy day arrives there will be significantly less need for economic analysts.
If Dr. Orszag had come to me with a plan to tie the ARRA to something that could be measured directly, say, Internal Revenue Service receipts of payroll taxes, which is a fair (not good) proxy for the unmeasurable unemployment rate, I’d think he was on to something. As it is, not so much.
Note that arguendo I have accepted his notion of the effectiveness of fiscal stimulus. Rather than being established fact that itself is a a matter of contentious dispute.
“There is no direct way to measure the unemployment rate. Consequently, there are many, competing ways of calculating it that produce different results. The unemployment rate is, therefore, analysis rather than data. The same is true, BTW, of gross domestic product and the rate of inflation.”
Brain is fried from too much call lately, but isnt this the fallacy of (forget exact name) needing perfect science? I think you can make a case that you would prefer no government intervention since you think it likely to make things worse or be ineffective. However, if you do think that there is a role for government intervention, dont you have to work with the data you have, not what you want? Yes, work towards better metrics, be skeptical about what you are using, but paralysis because you dont have an exact answer that you are 100% sure about seems like a poor decision.
Steve
What I’m arguing is that in the absence of objective measurements the choice isn’t between objective and non-objective but between whose non-objective measurements. The “data” are the result of a political process. I’m not looking for perfection but the absence of bias. In that case, I don’t think that the democratic process is so bad.
There’s a difference between working with the data you have, using it to inform decisions, and making the data the fulcrum for the mechanistic allocation of hundreds of billions of dollars in policy.
Dave,
I think there’s a bigger issue with his idea and that is politics. When a recession begins, what politician is going to get up to the lectern and declare that we shouldn’t do anything because we have “automatic stabilizers” in place? Politicians will have to be at least perceived as “doing something” and it seems to me whatever they do could very well mess up any “automatic stabilizers” that exist.
I don’t really know if there’s a solution here. I like the idea of a rules-based system too, but the unfortunately reality is that such systems are easily corrupted by the political process. After all, isn’t Medicare a rules-based system?
I think that Dr. Orszag may be imagining an economics that doesn’t exist in which automatic stabilizers have repealed the business cycle. In that imaginary world political interference wouldn’t occur because it wouldn’t be necessary. I think the very best case under his scenario would be that the field of action for politics would move.
Let me put it another way. I think that Dr. Orszag has created a clever strawman in which the present political process is contrasted with a prospective “data”-driven one. What he doesn’t take into account is that the “data” themselves are subject to political and ideological influence.
Rules vs. discretion. I agree with Dave that rules work better than discretion. The literature on this is pretty convincing.
I also see Dave’s point. It isn’t that we don’t have perfect data, or at least that isn’t the sole point. I think Dave’s point is that even if we could remove the discretion from the hands of politicians if we go with various things like the unemployment rate, NGDP, the inflation rate, etc. those all entail discretion as well or at least subjectivity. How do you measure inflation? Exactly what index to you use? And is that what you are really after? For example, the consumer price index was not intended to be a measure of inflation but as an upper bound on the cost of living index. The problem with a cost of living index is, as Dave notes, that it is unobservable. So one of the primary measures of inflation is clearly going to have issues. The various decisions on what kind of index to use and how to handle various problems are all dependent on people…people making subjective decision–i.e. discretion.
So if you say, “We need rules not discretion, lets build a rule around the unemployment rate.” You are really saying, “We don’t like politician discretion, but the discretion exercised by the various analysts at the BLS is fine.” I happen to know a bit about this from my time at the BLS. There was considerable research being done to try and make various statistical measures “better”. So it is not like there is some process that never changes and always gives out the right number.
In any event this all just nice theory crafting since no politician is going to give up his power of discretion. That is his bread and butter.
@Steve- When do we decide the data or measures are good enough to be useful? How do we decide?
Steve
Steve,
They are useful now. I would question whether they are sufficiently useful to be the lynchpin of policy. In the same way I find that my gps is useful, but it is not sufficiently useful that I’m willing to let it drive my car for me, nor am I even willing to give it sole control over what route I take.
If you have some information it is better than having none. Even if the information is not perfect.
If we were talking just about individuals there wouldn’t be much problem. But we aren’t. We are talking about collective decision making and game theory, when you get right down to it, and people are going to try and get the best advantage they can. So even though partial information might be helpful to the individual, in the collective decision making situation it can lead to all kinds of problems. In that setting dissembling is a given.
There is no data-based economic policy, as it has become clear over the last four years that economics is based on rampant ideology rather than empiricism. Look at the track record of our “leading lights” as they not only missed the coming financial crash but then saw each and every prediction they made fail to materialize: unchecked inflation, rising interest rates, sovereign defaults, monetary policy can regulate the economy; all hogwash. Instead of revisiting their models they simply fell silent for a time until they could figure out how to expalain away their errors and double down on the same nonesense they’d been peddling throughout their careers (Fama, DeLong, Bernanke, etc.)
There is zero chance any data gathered for the purposes of
crafting workable policies will not be manipulated by the zealots who continue to dominate the field.