The Great Experiment

In an op-ed in the Washington Post Jared Bernstein expresses skepticism about the likely effects of the recently enacted tax reform:

The timing of the tax cuts is such that they’re throwing a lot of fiscal stimulus—hundreds of billions in new, deficit spending—at an economy that’s already, on its own, closing in on full employment. Based on the already strong, negative trend in the unemployment rate, and the added stimulus, the unemployment rate could be in the mid-3s by the end of this year (it’s currently 4.1 percent). That’s a jobless rate we haven’t seen since the late 1960s.

As someone who constantly longs for very low unemployment, I welcome this development, should it come to pass. The tax cut is very poorly targeted; if I wanted to use the tax code to help those who’ve been left behind, I wouldn’t cut the estate tax. I’d significantly increase tax credits for low-income workers. But the Republicans, because they don’t care about the deficit when it comes to tax cuts, are engaging in an experiment that the more fiscally responsible Democrats would be unlikely to undertake: aggressive deficit spending at low unemployment.

How unusual is that? Well, looking at data back to the late 1940s, the average deficit-to-GDP ratio when unemployment was below 5 percent was close to zero. Since 1980, that same calculation yields an average deficit-to-GDP ratio of 0.5 percent. As I mentioned, the jobless rate this year may average less than 4 percent while the deficit-to-GDP ratio could be about the same, and closer to 5 percent next year. So, pretty unusual.

“Say’s Law” is a rule of thumb in economics that over time aggregate product necessarily creates aggregate demand and it underpins the reform. Dr. Bernstein’s op-ed is suffused with Keynesianism—the view that shortfalls in aggregate demand may persist and can be offset using deficit-driven fiscal stimulus.

My own view is that we’re engaging in fiscal stimulus in the absence of high unemployment but also in the absence of a shortfall in aggregate demand. If the tax reform causes an increase in business investment, it will be beneficial. If, on the other hand, the money is saved, retained in the form of cash or cash equivalents which include things like Treasuries, it won’t have much effect at all.

I believe that nowadays it’s very difficult to predict the results of fiscal policy because of globalization. The title I’d originally thought of for this post was “Stimulus in One Country”. I think that it’s quite possible that consumption effects of the tax reform might be to stimulate the Chinese economy.

6 comments… add one
  • Guarneri

    Several themes going on here.

    With respect to your last paragraph, look at an article in today’s ZH about the trade deficit.

    Say’s law needs to be treated more thoroughly. If I produce a bunch of pet rocks, will demand for pet rocks soar? What if I double the supply of rebar. Will demand for rebar skyrocket? I don’t think so.

    On the other hand, what about the demand for communications? People used to go about their day without being in constant contact with people and information. But with smart phones and the internet the demand has increased enormously. Was it latent demand unleashed by technology, or demand created out of thin air by supply? Or both. What about the demand for food…………and the supply of Chipotle’s, grocery stores, food carts on Lexington Ave or Morton’s steakhouses…………….. You get the point. This is really the debate over a general lack of demand vs product specific demand vs created demand.

    Which sort of leads us to saving and Treasuries and money balances. I wonder if you could expand upon the notion that saving (in Treasuries, bank CD’s, junk bonds, etc) does no good, as if the money went into a mattress.

    My view is that the capital markets simply redirect money from savers to users of capital. Maybe more Chipotle’s and fewer Mortons. Only by a change in the desire to hold money balances can really change demand. And that’s where one gets into animal spirits and risk vs reward and regulatory drag, which I always harp upon.

    Mr Say isn’t going to make me invest in production assets if the returns are not there or regulations make things too uncertain. And Mr. Keynes faith in government to deftly fill the demand void has, I think, been proven absurd the majority of the time. Democrats and far too many Republicans seem mostly hell bent on redistributing money balances as they see fit, not as the capital markets see fit. Its their nature. Only time will tell if Trump will stay true to, and can cobble together enough of a coalition, to let the private sector achieve the task. Optimism surveys, equity markets and savings rates certainly indicate that animal spirits have awakened.

  • PD Shaw

    For me, the question is what is the “normal” labor force participation rate?

    I see a rate that peaked at 67.3% in 2000. Slid to 65.8% following the early 2000 recession, and then to 62.5% following the Great Recession, and we are now bouncing around 63.0%, which is what it was back in 1978.

    I don’t see a general “employment problem.”

  • The baseline unemployment rate is misleading. Persistent inadequate job creation results in what are called “discouraged workers” who are no longer included in the calculation of the unemployment rate.

    Here’s a link that might put it into better perspective:

    Unemployment + Marginally Attached + Part-Time for Economic Reasons. And that doesn’t include discouraged workers.

    An additional problem is that there’s been a consistent pattern for a decade now: the jobs going away paid more than the jobs that are being created.

  • And Mr. Keynes faith in government to deftly fill the demand void has, I think, been proven absurd the majority of the time.

    I don’t think I’d say “absurd”. I think I’d be more inclined to say that it was inefficient because fine-tuning, either as to timing, size, or targeting was impossible.

  • PD Shaw

    Interesting, Dave’s link indicates that California’s U-6 unemployment rate is higher than West Virginia’s. I wait with bated breath for the WaPo’s multi-part article, “What’s the Matter with the Golden State?”

  • Guarneri

    This is the real problem:

    “An additional problem is that there’s been a consistent pattern for a decade now: the jobs going away paid more than the jobs that are being created.”

    “I don’t think I’d say “absurd.”

    Well, as you know, I’m never prone to hyperbole….. I do think the issues you correctly point to yield a result that can be described more robustly than just inefficient. Which reminds me of one of the early debates, and a comment of yours either here or OTB, concerning Kevin Murphy’s quantitative stab at describing the inefficiency of the stimulus package.

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