David R. Henderson  

Did the Federal Spending Cuts Slow Growth

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One of Scott Sumner's most important posts in the last few months is his November 8 post, "Mike Konczal: "We rarely get to see a major, nationwide economic experiment at work."

Scott quotes blogger Mike Konzcal from last April:

We rarely get to see a major, nationwide economic experiment at work, but so far 2013 has been one of those experiments--specifically, an experiment to try and do exactly what Beckworth and Ponnuru proposed. If you look at macroeconomic policy since last fall, there have been two big moves. The Federal Reserve has committed to much bolder action in adopting the Evans Rule and QE3. At the same time, the country has entered a period of fiscal austerity. Was the Fed action enough to offset the contraction? It's still very early, and economists will probably debate this for a generation, but, especially after the stagnating GDP report yesterday, it looks as though fiscal policy is the winner.

Before I go on, let me point out that what I like about Konzcal's post is that he was willing to state a test of the competing views.

Paul Krugman also agreed with the test, writing:

as Mike Konczal points out, we are in effect getting a test of the market monetarist view right now, with the Fed having adopted more expansionary policies even as fiscal policy tightens.

And the results aren't looking good for the monetarists: despite the Fed's fairly dramatic changes in both policy and policy announcements, austerity seems to be taking its toll.


Sumner summarizes the results of the test:
Yesterday I reported that RGDP growth in 2013 was running ahead of the pace for 2012, using either the official figures or the new Philly Fed GDPplus estimates. Today we received another strong jobs number, which means that employment gains in the first ten months of 2013 are running at over 186,000/month, versus less than 183,000/month last year and 175,000/month in 2011.

Given the predictions of the Keynesian model, anything even close to 2012 results would have been a win for MM [market monetarism]. The Keynesian model predicted a sharp slowdown from the higher income/cap gains/dividends taxes, payrolls taxes, sequester, government shutdown, etc, etc. But we are running ahead of 2012, and even if the last two months are weak we will be essentially even.


Scott's commenter Mark A. Sadowski is worth reading also. Sadowski wrote:
In other words, according to these estimates [by the CBO and by the Federal Reserve], the sequester should have decreased employment by about 640,000 jobs, and the tax increases should have decreased employment by about 500,000, as of 2013Q3. That's a total decrease of 1.14 million jobs.

Instead, employment was up by 1.7 million in 2013Q3 relative to 2012Q4. That's a significant increase from the 1.4 million jobs created in the previous three quarters.


This is huge. It fundamentally undercuts Krugman's version of Keynesianism. It's kind of like the famous late 1960s debate between Milton Friedman and Walter Heller about monetary policy vs. fiscal policy.

Interestingly, even when Konzcal claimed in April that we had an experiment, I pointed out that the data from the experiment were already showing that budget cuts don't seem to hurt the economy.


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COMMENTS (12 to date)
Steve J writes:

So is this description correct? A massive intervention by the Fed was able to offset a small reduction in the increase (not even an actual decrease) in federal outlays.

roystgnr writes:

Didn't we do a much bigger version of the "sharply contract government expenditures" experiment right after each of the World Wars? Did the results change anyone's mind?

Daniel Kuehn writes:

roystgnr -
And there are good reasons why it didn't change peoples' minds then - perhaps that should inform this current "experiment". But will it?

Phil writes:
Steve J writes:

So is this description correct? A massive intervention by the Fed was able to offset a small reduction in the increase (not even an actual decrease) in federal outlays.

Steve - Check your facts. There HAS been an actual decrease in outlays. Federal outlays in 2013 ($3.45T) were lower in then-year dollars, than 2012 ($3.54T) which was lower than in 2011 ($3.60T) . The last time the federal government had two consecutive years of real reductions in outlays was 1954-1955.

Heck, the last time it had ONE year in reduced outlays was 1965 (a meager $300M less than 1964).

Phil writes:

My error. FY 2010 was $60.6B lower than 2009. Prior to 2010, it was 1965 since the federal government spent less in a one year than it did the year prior (measured in then-year dollars).

Daniel Kuehn writes:

And the reduced projections for future spending matter too.

And this is before we even get into the states.

Steve J writes:

@Phil - My point is QE3 is a significant bond buying program and many people believe it may be causing an equity bubble. This massive Fed action offsetting what appears to be a very minor disturbance in the force of government spending is being considered a "win" by monetary policy. And I agree it is a win but I think it also demonstrates it requires unusual methods for the Fed to help the economy when interest rates are zero. After a successful tapering of QE3 this win will look much better. Buying bonds is certainly preferable to starting a war to fix the economy.

MingoV writes:
... the country has entered a period of fiscal austerity...
Federal government spending that's 25% greater than the 2008-2009 fiscal year doesn't seem like austerity to me.
John Thacker writes:

David, this is a large part about why I feel like you and Jim Pethokoukis were talking past each other somewhat recently. I think that the two of you broadly agree (believing that monetary policy can offset fiscal austerity, and favoring fiscal austerity with such an offset), but he seemed to take issue with your post about fiscal austerity in practice not having hurt the economy, because he opposes fiscal austerity that is not combined with monetary accommodation.

Steve J:
How can the Fed action be considered "massive" when it's had a small effect on interest rates and inflation? Why is the method considered so "unusual," other than the Fed normally preferring a method that doesn't work at the zero bound? If QE and NGDP targeting were the Fed's normal actions, then cutting the funds rate would look unusual.

If "unusual methods" are superior, then perhaps they should be your usual methods instead.

Andrew_FL writes:

Yeah, I don't know about anyone else but I got kind of a kick out of the notion that anything close to controlled experiment has happened here.

Anyway, if I am following this correctly:

Krugman argued:

1. There was "austerity."

2. Because of that "austerity" the economy would take a noticeable hit.

3. Fed policy would not offset it.

Whereas if I understand correctly Sumner argued:

1. There was "austerity."

2. By itself, that would be bad for the economy.

3. But Fed policy would offset it.

So, given that the economy did not take a noticeable hit, Sumner would conclude his 3 must be true? I regard that as a non sequitur. Why could one not instead conclude that Fed policy had nothing to do with it, it's just that both of there points 2 are wrong?

MikeP writes:

Indeed, it seems that this is the most likely analysis:

1. There was "austerity."

2. That is good for the economy because it means more scarce productive capacity is going to things people want and less to things people don't want.

3. The Fed hasn't yet screwed it up.

Steve J writes:

John Thacker - I stand by my claim recent Fed actions have been "massive".

http://research.stlouisfed.org/fred2/series/BASE/

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