David R. Henderson  

Chris Edwards on Time-Inconsistent Fiscal Policy

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To Keynesians, the short run is always more important than the long run, so it's impossible for them to have a "credible" long-run commitment to deficit reduction. Even today, prominent Keynesian economists are demanding more "stimulus," but the economy is not in recession and the budget deficit (which is "stimulus" to Keynesians) is already over $1 trillion. What happens if the economy slips into recession in 2013 or 2014? The Keynesians would surely break any budget deal and push for a $2 trillion deficit.
This is from Chris Edwards, "A Contradiction in Keynesian Fiscal Policy." The piece is short and well worth reading. This is one of the nicest brief expositions of time inconsistency that I've seen.

Edwards doesn't use the term "time inconsistency," but that's clearly what he's talking about. When I read such sweeping generalizations, the counter-arguer in me tends to look for counterexamples. The only one I could think of in recent U.S. history was Larry Summers and a few others persuading Clinton in 1993 to rein in the deficit in the short run. That's when Keynesianism was at a low point, though, and it wasn't even clear to me at the time that Summers was a Keynesian.


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CATEGORIES: Fiscal Policy



COMMENTS (16 to date)
Daniel Kuehn writes:

I'm scratching my head over this one, David. All the major Keynesians I can think of opposed the Bush tax cuts for precisely this reason. Most of the major Keynesians I can think of (excepting the real entitlement optimists like maybe Dean Baker or someone like that) have supported various approaches to guaranteeing long term deficit solutions along with the short-term spending proposals for precisely this reason. (Of course politicians can undo that but that's part of the point of getting legislation in place now so that it has some inertia, to overcome the time inconsistency temptation). It seems to me they emphasize exactly what Edwards says they neglect.

You struggle for counter-examples but I'm honestly struggling to think of prominent Keynesians that Edwards is fairly characterizing here.

This simply sounds wrong: "To Keynesians, the short run is always more important than the long run", but maybe he is shooting for some hyperbolic effect/poetic license.

And idea that we're not in a recession because - why? - the NBER says we're not in one? That seems odd too. Given how below trend spending and employment is, that claim was odd as well.

Daniel Kuehn writes:

This is also from the post:

"Thus, the best way for policymakers to be truly “credible” on deficit reduction is to start cutting spending right now."

I think Summers and DeLong would have a few critiques of this point.

A lot of this is hard to be convincing about because with the analysis in Summers and DeLong's new Brookings paper in mind, reading this sort of thing makes me feel like Chris Edwards is the one that isn't very convincing on the fiscal responsibility front. But of course, if you don't agree with the Summers-DeLong logic you might find him very convincing.

I wouldn't go as far as Edwards did though, and just infer that he must not care about the long run. I think he probably does care (I think most libertarians probably care about fiscal responsibility), but that doesn't mean he's right.

David R. Henderson writes:

@Daniel Kuehn,
All the major Keynesians I can think of opposed the Bush tax cuts for precisely this reason.
I thought they had opposed the part of the 2001 Bush tax cut that went to the highest-income people but not the part that “cost” the Treasury the most, namely, the child tax credit, the downshifting from the 15% to 10% tax bracket, etc. Could you give me a cite or two showing that I’m misinformed?

Costard writes:

Daniel - not my recollection. They opposed the tax cut on the grounds that it was regressive, they opposed in arguing that the nation's infrastructure was deteriorating, and if they ever raised the issue of deficits - I don't recall much worry about this in 2001 - they did so as a taunt to the conservatives who campaigned against Clinton on it. But perhaps some examples would enlighten me.

It seems silly to talk about Keynesianism in isolation. The theory has long been partnered with an ideology that finds it useful. Galbraith was arguing for deficits in the 90's while the economy boomed; Krugman pushed for spending during the housing bubble. This has nothing to do with the theory that deficits are a useful counter-cyclical tool, and everything to do with the belief that the federal purse is at all times more judicious and equitable than the private one.

"And idea that we're not in a recession because - why?"

We are not in a recession because the economy is growing, companies are hiring and deflation is nonexistent. You can redefine the term if you like, but at that point you have essentially ceded the argument. Unemployment is at 8%, but this is a different problem with a number of potential causes, and to advocate one solution for every ailment is not to argue a theory, but a slogan.

Eventually one gets the sense from these debates that we are not tilting at unemployment or aggregate demand, but instead the old set of windmills: just vs. fair distribution of wealth, social vs. individual goals, utopia vs. progress at the margins. On a fundamental level this is an ideology of the present -- a belief that through immediate and comprehensive action the world can be "fixed" -- a dry moralism. I don't think you can just dismiss Edwards' point.

I haven't read the paper from Summers and Delong but I'm familiar with their arguments. It's not their logic I disagree with but their assumptions. A castle in the sky doesn't require a siege or a battering ram, only an acknowledgment of gravity. But I'll allow that if morality consists solely of who you help and not who you screw, if happiness arises from having rather than doing, and if the economy is nothing more than a vending machine for jobs -- then their logic seems implacable.

Daniel Kuehn writes:

I'm not sure I understand the premise of your challenge, David. Did they or did they not oppose the reduction on top tax rates because they considered the damage done to the long term budget outlook to be a cost well exceeding any stimulative benefits or any egalitarian/normative benefits? My understanding was that that was exactly the cost-benefit reasoning of every prominent Keynesian on this. Am I wrong? This isn't too say there aren't benefits to tax reduction. The child tax credit is better stimulus (those are higher MPC taxpayers) and better egalitarianism (for obvious reasons).

Since the high end tax cut was neither of those things, and threatened the long-term fiscal position, the evaluation on that was very different. To say that the long-term budget outlook wasn't central to this discussion or to these analysts seems annoying and misleading at best, and dishonest at worst (and to be clear, I'm willing to assume the best).

Daniel Kuehn writes:

And its not just "Keynesians" either. I worked as a research assistant for Bob Reischauer for years in the mid-2000s. He doesn't really do macro, but he's one of the most highly regarded "liberal budget analysts" out there. The late Ned Gramlich is another one I've worked with (and he has had his hands in macro policymaking as well as the budget work). Nobody can tell me Bob or Ned cared about the short run over the long run. It's ridiculous, David. I'm not sure how familiar Edwards really is with the sorts of people he's criticizing here.

The sad thing is, if the post just said "we should focus on the long-term budget" you'd have a lot of Keynesians and liberal budget watchers saying "wow - something out of Cato to agree with!" rather than "what is he talking about?"

Daniel Kuehn writes:

"This has nothing to do with the theory that deficits are a useful counter-cyclical tool, and everything to do with the belief that the federal purse is at all times more judicious and equitable than the private one."

Talk about a strange statement in need of citation. Who thinks this, exactly???

Daniel Kuehn writes:

Compiling citations now. I suppose it is a reasonable request on both your parts.

This just really irks me. How does this sound: when you see what I pull up, if I demonstrate there is a real and long-standing concern for the long-term budget outlook and policy advocacy to address the long-term budget, you retract the accusation and request that Edwards retract it too. I may be taking this too personally, but I doubt anybody else that spent several years on the fifth floor of 2100 M Street during the Bush administration would be taking Edwards very seriously right now either. His post strikes me as unalloyed nonsense, and the more I'm pulling up the more firmly I think this.

David R. Henderson writes:

@Costard,
They opposed the tax cut on the grounds that it was regressive
It’s possible that they did; if so, they were mistaken. The 2001 tax cut cut income taxes by a higher percent for low-income people than for high-income people.
@Daniel Kuehn,
Did they or did they not oppose the reduction on top tax rates because they considered the damage done to the long term budget outlook to be a cost well exceeding any stimulative benefits or any egalitarian/normative benefits?
I don’t know. That doesn’t address my point. The cuts in top tax rates were responsible for a small part of the revenue loss to the Treasury.
How does this sound: when you see what I pull up, if I demonstrate there is a real and long-standing concern for the long-term budget outlook and policy advocacy to address the long-term budget, you retract the accusation
If it does so to my satisfaction, yes. As you know, Daniel, from being a regular reader of this blog, I’ve often made mistakes and admitted them.
and request that Edwards retract it too
No. I don’t engage in that kind of thing. You will find me having criticized Greg Mankiw, Paul Krugman, Larry Summers, Tyler Cowen, Ron Paul, Bob Murphy, Christina Romer, and many others on this site. Not once did I request that any of them retract what they said. I find that kind of behavior obnoxious.

Daniel Kuehn writes:

I've got to confess I have no idea what the child tax credit point is. Aren't we interested in the biggest bang for your buck for the Treasury, also keeping in mind long-term consequences?

Fair enough on what's obnoxious. I hope you can appreciate how obnoxious the initial post from him came across too, though.

Ken B writes:

As another example, how about Chretien-Martin in Canada? They aggressively cut deficits in Canada in the 90s, including cutting long term committments.

Harper has more recently offered at least some resistance to stimulus mania in Canada. Not enough, but some.

David R. Henderson writes:

@Ken B,
Good example, which I wrote about at length here:
“Canada’s Budget Triumph."
I’m not sure to whom you’re addressing this example, though. In their decisions, Chretien and Martin were very non-Keynesian. Indeed, here’s a quote that I used from Martin’s autobiography, Hell or High Water:
It is important to understand that the no-deficit rule was a sharp break with tradition. In the postwar years, many economists argued that you did not need to be in the black every year, as long as budgets were balanced over the course of the economic cycle, so that deficits during slumps would be paid off with surpluses in good years. Whatever the economic rationale for that approach, it didn’t work in the real world of politicians. Once you break the spell— once governments find that they can get away with borrowing instead of taxing to pay the bills—it is almost impossibly tempting for politicians to do it again and again until the debt is out of control.

Ken B writes:

@DRH: I will read the article, thanks. My comments were partly an inquiry. The Martin quote is interesting. I don't understand though why you think this was anti-Keyenesian. It sounds to me like he says the economists argued you should be balanaced, but politicians hooked on the debt drug were not, and he was (a fair boast). Isn't that "I was a proper Keynesian"?

Chretien-Martin REALLY surprised me at the time. I was raised a grit, but by then had become a Reformer [for American readers: much more small govt party in most ways but lumbered with a social conservative streak].

David R. Henderson writes:

@Ken B,
Isn't that "I was a proper Keynesian"?
Touche.

David R. Henderson writes:

@Ken B,
I take it back. If you have a no-deficit rule that you follow at all times, as Martin argued that you should, you can’t be a Keynesian in policy.

Ken B writes:

@DRH:
Oh no! I'm holdin' tight to that touche. I'll send you a picture when I have it framed! :)


Actually I took Martin to mean he'd tough out any setbacks, no deficits now until we're clean & sober, rather than a universal rule, but I might be misreading.

Your article had some good bits on UI. The role of UI in destroying the Newfoundland cod fishery is interesting and important. The federal governement sudsidized overfishing by letting fisherman use shorter periods of fishing count towards collecting unemployment insurance, so they stayed and fished rather than moved to Ontario. The tragedy of the commons amped up.

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