Economics in 1.5 Days

I recently attended an economics conference. I know you're dying to know how it went. Don't laugh. No one at the conference did.

Are we headed for a double-dip recession, or even a Great Depression? How will the U.S. and most of the developed world face their debt problems? How bad is all that debt, and where will it lead? What exactly happened that caused our recent financial crisis, and how can we prevent such a thing in the future? As our lawmakers and political leaders craft new fiscal, monetary, and regulatory policies, what should they do?

Good questions. Too bad they weren't answered at the conference I attended. Then again, economists are only human and must rely on data, mathematics, and the principles of sound statistical inference. Apparently, predicting the future is still a tricky enterprise.

But they did what they could. Here, for example, are a few tidbits from their studies.

  • The optimal tax rate for a flat (marginal) income tax is 19.5%. That tax would raise the same amount of money as our current income tax, with everyone having the exact same marginal rate as each other and everyone feeling better off for it. This system would include a negative income tax for low earners.
  • About one half to two-thirds of the cars sold under Cash for Clunkers would have sold in about the same time period even without the program. So the cost to taxpayers for each car sold due to the program was about $15,000. Some studies put it at $24,000 per clunker.
  • The math textbook your kid uses in grades 1-3 can influence his math test scores in later years (at least up to grade 6). The amount of influence? About 0.11 standard deviations (maybe one to two percentile points), while it lasts.
  • Banks really do achieve economies of scale (efficiency) by getting bigger, even already big banks.

There was one inconsequential paper that showed that just about anyone could date recessions as well as the National Bureau of Economic Research yet provide more consistent calls than the NBER's dating committee. (That was the paper I presented. You might have read its precursors here and here.)

However, there was a theme to a few of the presentations, especially the one given by Nobel Prize-winner Finn Kydland. (The picture on the left, below, shows Dr. Kydland presenting to the crowd. The picture on the right shows Dr. Kydland in the middle, with Maxim Nikitin, an economist from Russia, and me.) 











Dr. Kydland called it an "anomaly," or something not explained by current economic theory. 

And that anomaly is this: While developed countries are largely coordinated in their monetary policies, their economic outcomes in terms of real growth are all over the map. That is, why don't countries with similar monetary policies experience similar economic growth?

Another paper examined much the same thing with price levels, or inflation. If monetary policy dictates inflation, why don't countries with the same monetary policies have the same inflation rates, more or less? Yet they don't, or at least the connection is weak. Another anomaly.

Yet another paper noted that a government's budget deficits (or surpluses) are not totally influenced that government's fiscal policy. In fact, about 40% of a government's deficit is explained by some "global" influence. Developed economies seem to experience similarly timed ups and downs in government deficits.

All these papers have in common the discovery (and the dilemma, if you are an economist) that the big tools of government economic policy, namely monetary and fiscal policy, have little influence on real economic outcomes.

Dr. Kydland was effectively telling a room full of monetary economists that monetary policy seems to have almost no effect on the real economy. That's as close to calling their baby ugly as it gets. Dr. Kydland gave them the news with enough mathematics that maybe they didn't notice.

This "anomaly" is a really big deal to economists. They take it to mean that global influences are as important as, or even more important than, domestic economic policy on a country's real economy. The Dallas Federal Reserve, in fact, split its monetary research group into two parts; one part is now devoted to global monetary analysis.

I have a simpler interpretation: Government can't really do much for an economy, other than screw it up.

It seems to be accepted knowledge, especially among Democrats, that a government stimulus produces jobs and "fixes" a recession. Yet there is plenty of evidence that shows that fiscal policy in general, much less a stimulus in particular, does nothing of the kind.

I would like to cite two academic economic papers written in 1992 and 1994 (bear with me on this). The papers are titled "What Ended the Great Depression?" and "What Ends Recessions?" The author concluded that

[p]lausible estimates of the effects of fiscal and monetary changes indicate that nearly all the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion... That monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.

We find that the Federal Reserve typically responds to downturns with prompt and large reductions in interest rates. Discretionary fiscal policy, in contrast, rarely reacts before the trough in economic activity, and even then the responses are usually small.

In other words, fiscal policy, or spending, had almost nothing to do with ending the Great Depression or other recessions, try as the government might.

Now here is the kicker: the author of those papers was none other than Christina Romer, who is now President Obama's Chair of the Council of Economic Advisors.

Yes, ladies and gentlemen, the economist who concluded that stimuli do not help end recessions was Obama's chief champion for a $787 billion "stimulus." (Aren't you glad that liberals don't "sell out"?)

And now, with so much global trade, economists are finding that even monetary policy is losing its kick.

Tell me, boys and girls: If monetary policy is largely powerless, and fiscal policy is powerless, then what should a government do to "run the economy"?

The answer is that a government can't run an economy. It cannot even influence an economy much, at least not for the better. What it can do that would be helpful is provide institutions that protect life, liberty, and property.

And that lesson is not new. In fact, it is what Adam Smith told us over two hundred years ago.

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.

I get the feeling that a whole lot of wonderful mathematics is being wasted in failed attempts to find loopholes in that statement. But governments are willing to spend a lot of money on economists willing to try. That is in the government's self-interest. And self-interest is something economists do know a lot about.

Randall Hoven can be contacted at randall.hoven@gmail.com or via his website, randallhoven.com.
If you experience technical problems, please write to helpdesk@americanthinker.com