What If Fairies Are Real?

Paul Krugman, Noah Smith, and others have written derisively about the “Uncertainty Fairy”, alternatively the “Confidence Fairy”. What if fairies are real?

Three economists, Stanford University’s Nicholas Bloom and Scott Baker and the University of Chicago’s Steven Davis, have done invaluable work measuring the level of policy uncertainty over the past few decades. Their research (available at policyuncertainty.com) shows that, on average, U.S. economic policy uncertainty has been 50% higher in the past two years than it has been since 1985.

Based on that research, our economists at Vanguard isolated changes in the U.S. economy that we determined were specifically due to increases in policy uncertainty, such as the debt-ceiling debacle in August 2011, the congressional supercommittee failure in November 2011, and the fiscal-cliff crisis at the end of 2012. This gave us a picture of what the economy might look like if the shocks from policy uncertainty had not occurred.

We estimate that since 2011 the rise in overall policy uncertainty has created a $261 billion cumulative drag on the economy (the equivalent of more than $800 per person in the country). Without this uncertainty tax, real U.S. GDP could have grown an average 3% per year since 2011, instead of the recorded 2% average in fiscal years 2011-12. In addition, the U.S. labor market would have added roughly 45,000 more jobs per month over the past two years. That adds up to more than one million jobs that we could have had by now, but don’t.

I think that one of Bill Clinton’s unnoted accomplishments was his ability to act as cheerleader for the American economy and one of George W. Bush’s greatest weaknesses his lack of ability to create similar confidence. There was a sharp drop in the Dow when Bush took office. I attribute at least some of that to the Clinton effect. I have repeatedly questioned President Obama’s talking down of the economy, something that began even before he took office.

I’m not saying that the president should be engaging in happy talk in the face of disaster. What I think is that it’s possible to strike a balance. Read some of Franklin Roosevelt’s “fireside chats”.

And I don’t disagree that faster economic growth would have dispelled some of the uncertainty. However, if you don’t know how to produce growth (or are unwilling or unable to do what it takes to produce growth), there are other ways of fostering greater confidence. Why not try that for a change?

34 comments… add one
  • Red Barchetta

    “I think that one of Bill Clinton’s unnoted accomplishments was his ability to act as cheerleader for the American economy and one of George W. Bush’s greatest weaknesses his lack of ability to create similar confidence.”

    Absolutely correct. In perspective, GWB’s economy was quite good, no matter your view on what happened at the end. I think his personality did not allow him to self aggrandize.

    “I have repeatedly questioned President Obama’s talking down of the economy, something that began even before he took office.”

    My point for what now, 4 years+ ?? You go on and on about downtalking the economy AND you put idiotic headwind policy in place?? What do you expect? Michael can go on pathetically stupid and just morally offensive rants about “nigras” and so on, but really, what does one expect for growth and employment in this environment?

    “However, if you don’t know how to produce growth (or are unwilling or unable to do what it takes to produce growth), there are other ways of fostering greater confidence. Why not try that for a change?”

    Again, my central theme. One can have a worldview on regulation, taxes etc. But the fact is we have massive (and underestimated)unemployment and sluggish growth. What kind of a moron doesn’t take a completely different tack and try to jump start the place. People are hurting.

    I’ve said it so many times: Obama is incompetant, and is the fortunate son of the gift of gab, serendipity, and a slobbering press. What a price for the Average Joe to pay.

  • Ben Wolf

    When austerians were talking about restoring “confidence” back in 2010-2012 they were referring to Barro’s version of Ricardian equivalence, that once capitalists (not consumers) became sure that future taxes would not have to increase to pay down accumulating public debts, those capitalists would spend and revive the economy. Europe has utterly demolished this notion that deficit reducion would create a “contractionary expansion”. The experiment running there for three years now shows no signs of the confidence fairy’s flight taxiing into the terminal. To the contrary the eurozone has deliberately chosen a new Great Depression by raising taxes and cutting spending.

    Absolute insanity.

    For businesses and consumers there has absolutely been a crisis of confidence. You’d have to be insane to invest when you have no reason to expect increased sales or to buy when you have no confidence in employment.

    And yes, I agree with Drew the President is an economic ignoramous.

  • What bugs me about this entire subject is the denial. There is ample evidence that the president and his advisors got exactly the stimulus they wanted and very little evidence that they really wanted more. There are multiple quotes from virtually everyone involved that contradict that belief.

    I’m still looking in vain for a non-circular objective definition of “austerity”. In Greece real government spending has decreased and taxes have gone up. That would fit my definition of austerity. In the U. S. federal government and the U. K. real spending have remained just about the same and taxes have risen. That’s described as austerity, too.

    In the U. S. total spending by government at all levels has risen slightly while taxes have increased. Depending on how you calculate inflation spending also might be declining slightly. That’s also characterized as austerity.

    The problems in the eurozone and in the U. S. are really quite different. Unless Germans are willing to pay for Greek spending, the Greeks really have no other choice but austerity.

  • PD Shaw

    Any austerity argument also needs to address whether any shrinkage of the government sector was part of a longer pattern:

    Federal government jobs (Civil Servants, Postal Workers, Military):

    1990: 5,161,000
    2005: 4,075,000 (21.042% decrease)

    Estimate of federal government contractors and grantees:

    1990: 7,474,000
    2005: 10,526,000 (40.835% increase)

    https://wagner.nyu.edu/performance/files/True_Size.pdf

  • When austerians were talking about restoring “confidence” back in 2010-2012 they were referring to Barro’s version of Ricardian equivalence, that once capitalists (not consumers)….

    Link please. I find this hard to believe given the hostility that many Austrian school economists have towards the mathematical approach used by economists like Barro.

    …that once capitalists (not consumers) became sure that future taxes would not have to increase to pay down accumulating public debts, those capitalists would spend and revive the economy. Europe has utterly demolished this notion that deficit reducion would create a “contractionary expansion”.

    Not raising taxes to pay for accumulated public debts and deficit reduction are two very different things. So this line of reasoning starts off wrong. You might have gotten to the right answer, that not raising taxes would not have lead to greater growth, but you can’t get there by pointing to deficit reductions via spending cuts.

    The experiment running there for three years now shows no signs of the confidence fairy’s flight taxiing into the terminal. To the contrary the eurozone has deliberately chosen a new Great Depression by raising taxes and cutting spending.
    –emphasis added

    The bold part suggests that Europe was not pursuing an Austrian policy since you claim Austrians were advocating not raising taxes.

  • Steve V.’s comment ties back to my puzzlement over the operative definition of “austerity”.

  • PD Shaw

    Is “austerian” synonymous with “Austrian” school? Or is it a pun that doesn’t mesh 100% with the economic theories?

    http://www.ritholtz.com/blog/2010/06/word-origins-austerians/

  • Heh, when I first read it I thought Ben was talking about Austrians.

    Still, not raising taxes is different than austerity–i.e. cutting spending.

  • BTW, to make sure everyone knows this…

    I have not been in favor of big spending cuts. My own view is that we limit future spending via program revisions such as means testing Social Security, Medicare, and other policy changes. I don’t mind seeing spending cuts…or savings by bringing much of the military home from their overseas “adventures”. I also wouldn’t mind seeing other limits on future spending such as limiting spending so that the spending-GDP ratio remains roughly constant or has some fixed upper bound.

    I know many cornucopians will see this as catastrophe and set their hair on fire.

  • steve

    “What bugs me about this entire subject is the denial. There is ample evidence that the president and his advisors got exactly the stimulus they wanted and very little evidence that they really wanted more. There are multiple quotes from virtually everyone involved that contradict that belief.”

    Not what I have read. Romer wanted a stimulus about twice the size the one they got. Obama and his advisors did not think it was politically possible to go over a trillion dollars. Summers thought it would be enough anyway. What you forget is that no one knew how bad of a recession we had entered. Revisions to GDP for 2008 showed the last 2 quarters to be much worse than thought.

    Not sure it matters though. If you are going to use public spending to let private balance sheets repair, you need to start with low public debt levels. We didn’t have those.

    Steve V- The Austrians confuse me sometimes with their aversion to math and data. At heart I am an empiricist but the arguments of, some, Austrians seem to hold nothing but disdain for such. For those who have read Hayek I think they misunderstand them, but I will confess to not having read enough Mises to know if he really promoted such an aversion.

    Steve

  • Ben Wolf

    @Dave Schuler,

    There isn’t a generally accepted definition I would find satisfactory, one which is at least nominally objective rather than judgemental. My personal definition, after observing the policies put into effect as well as the stated goals would be something like:

    Policies directed at reducing budgetary outflows from the government sector to the non-government sector with the intent of demonstrating commitment to the principles of Sound Finance, thereby increasing investor confidence in the nation’s long-term fiscal position and generating renewed, sustainable growth.

    The only theme tying together all these various policies we see across the planet, however, is deficit reduction. Reduced by how much, how fast or by what measures is ambiguous at best. Australian and U.K. efforts at what they refer to as austerity have resulted in greater deficits, while under the U.S.’s (relative) budget neutrality deficits fell from 12% GDP in 2009 to a projected 4% this year, the fastest “deficit reduction” I’m aware of in 80 years of economic data. But a fall in deficits due to automatic stabilizers is not, it seems, considered austerity; apparently politicians have to be seen “doing something” in order to assure investors.

  • Ben Wolf

    @Steve Verdon,

    I’m referring to Barro because that’s who’s name was often invoked when austerity was being debated at the time, not because I think Barro considered tax hikes as being excepted from public internalization of policy if instituted immediately. Politicians took Barro’s suggestion aggregate demand could not be increased by spending to mean that investment and investors must be looked to for restarting growth, not considering that there is no point investing if there is no-one to sell to.

  • Obama and his advisors did not think it was politically possible to go over a trillion dollars.

    Citation, please.

  • Steve V- The Austrians confuse me sometimes with their aversion to math and data. At heart I am an empiricist but the arguments of, some, Austrians seem to hold nothing but disdain for such. For those who have read Hayek I think they misunderstand them, but I will confess to not having read enough Mises to know if he really promoted such an aversion.

    Some Austrians believe that they are working from premises that are essentially true, and as such whatever results they derive are also therefore true. No need for empirical verification. Or something like that. I think you still see this with people that are connected to the Mises Institute.

    Lately some have been veering away from those beliefs. One article I read awhile ago talked about how Austrians should embrace game theory.

  • steve

    Ask, and ye shall receive.

    http://www.newyorker.com/reporting/2009/10/12/091012fa_fact_lizza

    But this one is better. Has copies of Romer’s memos.

    http://www.newrepublic.com/article/politics/100961/memo-Larry-Summers-Obama#

    If you want more, let me know.

    Steve

  • The first one doesn’t say what you’re saying. It says that there was no serious discussion of a stimulus over $1 trillion. Your interpretation is that it was for political reasons.

    The second one says that Summers scotched any stimulus over $1 trillion. Not that the political players refused or that it wouldn’t get passed. That it was his assessment that it was impractical.

    See here for a defense of the stimulus from Christina Romer. Apparently, she thought it was just right. If she thought otherwise, that’s asserting that she violated her professional obligations.

    You’re in denial, steve. You’re simultaneously arguing that the administration knew it needed more and didn’t know it needed more; that it wanted more and that it refused to ask for more. It would be reasonable to argue that Summers and Romer violated their professional obligations. It would be reasonable to claim that the administration asked for the wrong thing. I don’t find it reasonable to argue that the administration wanted a larger stimulus. I think it got exactly what it wanted.

    More evidence, please.

  • Politicians took Barro’s suggestion aggregate demand could not be increased by spending to mean that investment and investors must be looked to for restarting growth, not considering that there is no point investing if there is no-one to sell to.

    Barro never stated that government spending cannot increase aggregate demand, at least that was not the gist of the Ricardian equivalence theorem. That theorem held, that in certain conditions deficit spending would not work to increase aggregate demand. The conditions are rather stringent such as perfect capital markets.

  • What you forget is that no one knew how bad of a recession we had entered. Revisions to GDP for 2008 showed the last 2 quarters to be much worse than thought.

    If Romer was initially saying $1.7 – $1.8 trillion and she honestly felt that was a reasonable number that indicates the above is not quite true.

  • Red Barchetta

    “I know many cornucopians will see this as catastrophe and set their hair on fire”

    Won’t set mine on fire. I’m an LBO guy. Sometimes you get yourself in a pickle. You slowly, but definitively, work your way out. You deal with your economic realities; it might be messy and it may take a damned long time – a damned long time – but you work your way out of it. Its really the only option other than catastrophe.

    But that means admitting you are in the sink, and starting to deal with it. Our current president is diving into the sewer. He has no clue. He scares me.

  • TastyBits

    @steve

    … no one knew how bad of a recession we had entered. …

    While the smartest people in the world were clueless, many people knew it was going to be really bad for a long time.

    In January 2008, the following was known:

    1. The 2005 & 2006 ARM’s would reset.
    2. The resets were going to be harsh.
    3. There were going to be many foreclosures.
    4. The 2007 resets foreshadowed 2008.
    5. Housing prices would not rise forever.
    6. A recession was coming.
    7. The recession would affect the coming resets.
    8. The people in these ARM’s could not afford the resets.
    9. These mortgages had been packaged into MBS’s.
    10. Many MBS’s were purchased by pension/safe funds.
    11. CDS’s were written to provide “insurance” for the MBS.
    12. The CDS “underwriters” had levered “naked” CDS’s.
    13. The primary CDS’s were underfunded.
    14. The “naked” CDS’s had permeated among hedge funds & others.

    These were all interconnected. A “house of cards” had been built, and when one card was removed, there would be a cascade.

    In January 2009, a lot of money had been funneled into AIG to payoff the “naked” CDS’s to try to staunch the financial crisis, but nothing about the housing crisis had changed.

    If the Obama economic team was too stupid to know this, why were they allowed to make any decisions.

  • steve

    “There were sound arguments why the $1.2-trillion figure was too high. First, Emanuel and the legislative-affairs team thought that it would be impossible to move legislation of that size, and dismissed the idea out of hand. Congress was “a big constraint,” Axelrod said. “If we asked for $1.2 trillion, it probably would have created such a case of sticker shock that the system would have locked up there.” He pointed east, toward Capitol Hill. “And the world was watching us, the market was watching us. If we failed to produce a stimulus bill, that in and of itself could have had deleterious effects.”

    From the first article.

    “If keeping the economy growing was so central for Obama, why was the initial stimulus “only” $800 billion? “The case is quite compelling that if more fiscal and monetary expansion had been done at the beginning, things would have been better,” Lawrence Summers told me late last year. “That is my reading of the economic evidence. My understanding of the judgment of political experts is that it wasn’t feasible to do.” Rahm Emanuel told me that within a month of Obama’s election, but still another month before he took office, “the respectable range for how much stimulus you would need jumped from $400 billion to $800 billion.” In retrospect it should have been larger—but, Emanuel says, “in the Congress and the opinion pages, the line between ‘prudent’ and ‘crazy spendthrift’ was $800 billion. A dollar less, and you were a statesman. A dollar more, you were irresponsible.” The three Republicans who voted for the stimulus bill—Susan Collins and Olympia Snowe of Maine, and about-to-be-Democrat Arlen Specter of Pennsylvania—all complained that it was far too large, as did Jim Webb and many other Democrats.”

    http://www.theatlantic.com/magazine/archive/2012/03/obama-explained/308874/3/

    http://articles.washingtonpost.com/2012-08-10/opinions/35492297_1_stimulus-recovery-act-tax-cuts

    (Note that the Minnesota seat was not filled yet. They needed a GOP vote to pass the bill.)

    The moderate Dems like Nelson were trying to make the bill smaller.

    http://www.foxnews.com/politics/2009/01/30/influential-senate-dem-questions-party-support-stimulus/

    http://www.newnebraska.net/diary/1677/

  • steve

    Dave- Comment with links in moderation.

    TB- Obvious in retrospect. Remember that in 2008 a lot of people denied that a recession was coming. To predict the second worst quarter since the Great Depression and plan around that would not have been accepted. It took two years to get the revised numbers.

    Steve

  • I don’t read those quotes the way you do. I read those as Summers violating his professional obligations and post hoc rationalization of the sort that you’re doing. They would say that, wouldn’t they?

    Remember, that first article also says there was no serious discussion of a stimulus package over $1 trillion. No serious discussion is no serious discussion. It doesn’t mean that there was serious discussion of how it was impractical. It means it wasn’t discussed. Anything after that is just rationalization.

  • BTW, although RB, Steve V., and TB may disagree with this assessment I think the president genuinely wants to do the right thing. I think he’s not particularly well-informed and he’s horribly ill-served by his advisors. He has all of the problems that every president does in getting good advice with an additional, unique problem. Race never leaves his advisors’ minds. They don’t want to disagree with him for the reasons advisors don’t want to disagree with presidents but also because they don’t want to think of themselves as racists.

  • steve

    Then we will just have to disagree. If both Axelrod and Rahm thought it was too difficult to go over a trillion, I think that is a political decision. If we have contemporaneous quotes from Nelson saying he would not go over $800 billion, I think that is evidence of political considerations. I think it is pretty clear that Romer wanted a larger stimulus. It also seems pretty clear that Summers cut out the recommendation for a $1.8 trillion plan. Did he do that for political or economic reasons? Since he was the economic star of the group, I can see him trying to cover his ass, but quotes from Axelrod and Rahm seem to support him. Again, they only had 59 votes in the Senate. They needed at least one GOP vote. How could they not make a political decision?

    Steve

  • Andy

    There may not be any solid evidence, but I think there is a psychological threshold at the “T” word and I think it’s pretty safe to assume that the WH was aware of that threshold. I think the same rationale was used when the President arbitrarily determined that the PPACA should cost no more than $900 billion over a decade (it’s not clear to me why that particular figure was picked beyond the the fact it was less than the “t” word). The $900 billion was taken seriously by Congress though – just look at some of the creative things that were put into the legislation to keep it around that number.

    At the same time I think Dave is right that there isn’t a lot of evidence the WH wanted a bigger stimulus at that time. Given that the stimulus failed at achieving its policy objectives, it’s not surprising that those in the WH who supported it now say that the reason they didn’t go for a bigger bill was because of Congress.

    Additionally, let’s remember that the WH doesn’t make policy. They can name any figure they want but Congress ultimately crafts the bill and decides how much to spend. The house and Senate bills started fairly small and then grew over time. The Either house could have passed a larger bill independently or could have sent a larger bill to the President. Does anyone think he would not have signed a larger bill?

    Ultimately, it doesn’t much matter IMO, because even if the WH actually wanted a bigger stimulus, the Congress passed what it passed and I don’t think the President could have compelled Congress to do much more. The $787 billion stimulus that did pass had no GoP support in the Congress and only got through the Senate thanks to 3 GoP votes. The key question, therefore, is whether the President could have gotten those three Senate votes with a larger bill. Maybe if it was $100 billion more, but $1.5 trillion? Not a chance.

  • TastyBits

    @steve

    In January 2009, the following was known:

    1. The programs that were hailed as saving the financial system had actually been funneled through AIG, and it saved the fortunes of the other Wall Street firms.

    2. None of the money the government threw at the problem went towards the mortgage crisis. It had not changed, and it was getting worse.

    3. All the paper built on these mortgages was no better.

    4. The CDS’s that were supposed to insure their AAA rating would never payout, and the trash would be around for a long time.

    5. The Fed was trying to sop up much of this trash, but there was still a lot on the bank books and in safe funds – money market, pensions, etc.

    6. If the trash were marked-to-market, the banks were insolvent, and there would be few new shareholders.

    7. The existing housing stock was huge. Many of these houses should never have been built, but they were. Like the unemployed, many homeowners had given up trying to sell their homes, but as prices rose, they would come onto the market.

    8. Few new houses would be built, and any housing led recovery would not occur for years.

    9. Growth has been based upon credit being created, but banks were not able to extend credit to risky borrowers.

    10. Consumers who cannot borrow cannot spend. Hence, consumer demand was not going to help any recovery for a long time.

    11. If aggregate demand drives investment, there was not going to be any business investment for some time.

    12. A lot of money that would be used to maintain and grow the economy was stuck in bad loans, and it would be stuck for a long time.

    There was no need to wait to determine how bad things would get. It was going to get bad, and it was going to stay bad for a long time.

  • TastyBits

    @Dave Schuler

    I would agree with most of your assessment. I do think the stimulus package was a boondoggle for Democratic interest groups, and I do not think there is a lot government can do to help business.

    If it were possible for a stimulus package to be successful, it would need to be designed like a rocket’s flight system. The thing would be propelled into the right direction, and it would require constant course corrections. In reality the course corrections would be an opportunity to change direction.

    I try to stay away from writing about my assessment of the President. It usually devolves into a food fight, but I think you put forth a reasoned position without the partisanship. I do not think the President or Democrats are trying to crash the economy, but they sure do look like it.

    I tend to agree with @Drew that the President is incompetent, but I would rather not wasting my time arguing over it. I try to concentrate on keeping the past from being thrown down the memory hole.

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