Washington is starting to absorb Goldman-Sachs latest missive on the projected economic effects of the budget cuts proposed by House Republicans.
At first glance, it’s not good (ABC News):
A confidential new report prepared by Goldman Sachs for its clients says spending cuts passed by the House of Representatives last week would be a drag on the economy, cutting economic growth by about two percent of GDP.
“Under the House passed spending bill [which cut spending by $61 billion],” says the report, which was obtained by ABC News, “the drag on GDP growth from federal fiscal policy would increase by 1.5pp to 2pp in Q2 and Q3 compared with current law.”
Naturally, the Democrats are all touting it, while Republican Speaker John Boehner’s office is dismissing it (same link).
I decided to do a little digging into the report first. Mainly, I was looking for G-S’s multiplier.
For those who are not aware: the multiplier is what economist use to measure the effect of government spending on the economy. As I described here, a multiplier of 3, for example, would turn $1 of government spending into $3 of economic growth (or, as more appropriate here, a cut of $1 in government spending cuts growth by $3).
For “Old Keynesians,” the multiplier is a straightforward and simple way of measuring how government spending improves the economy. For the rest of us in the field, it’s not so simple. Old Keynesians tend to ignore the effect of government spending on available funds for the private sector entreprenuers and business. Financial investors can choose between private companies and U.S. Treasury notes; the more the government borrows, the less these folks will invest in the private sector. This “crowding out effect” (i.e., private business are crowded out of the funds available from investors) can reduce the impact of government spending (as shown in the multiplier).
Recent analyses, in fact, have shown a dramatic crowding out effect: the International Monetary Fund determined the multiplier to be 0.7 (John Taylor); the European Central Bank had an even lower figure: 0.5. Both of these mean that the “multiplier” is in fact a divider (i.e., $1 of government spending leads to only 50 or 70 cents in growth). Harvard economist Robert Barro actually find a multiplier of zero (Taylor).
So, what does Alec Phillips (the G-S economist) use as his multiplier? He doesn’t come out and say it, but this paragraph lets us pull it out (ABC again):
(Shutting the government down for the whole month of March) would equate to $32bn in annualized terms, or around 0.2% of GDP for each week of shutdown. Pulling this spending out of Q2 would reduce the contribution to quarterly GDP growth from federal activity by a little over 0.8pp (RWL note: short for percentage points) at an annualized rate for each week the shutdown lasted . . .
So a 0.2% of GDP cut in government spending would lead to of reduction in growth by 0.8 percentage points – that’s a massive multiplier of 4. Even some Old Keynesians don’t use multipliers that high; New Keynesians and non-Keynesians would consider it laughable.
More to the point, it is completely outside the trend of recent analysis.
It reminds me of something I had drilled into my head in my undergraduate and graduate students days from economics professors: “garbage in, garbage out;” i.e., bad data, bad variables, or a bad model lead to bad analysis no matter how much you dress it up.
In the end, that’s what Goldman-Sachs did here. They plugged numbers into a terrible model and came up with an “analysis” that isn’t worth the bandwith on which it was carried.
Or, as my old professors would say: garbage in, garbage out.
[...] Cross-posted to RWL [...]
Crowding out?
at these rates:
http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
so the money is chasing these kinds of rates over other investments?
come on DJ… what were you saying about “garbage in”?
how will you guys ever get it straight if you won’t admit even some basic realities here?
The tax rate – is the lowest in what – 60 years?
and cutting spending? ha ha ha
how are you going to find 1.5 trillion dollars in the current non-FICA budget without deep cuts in military, Medicare and General Govt?
Bonus Question – do you consider the recommendations in the 2 deficit commission reports to be Keynesian “garbage in” / “garbage out” also?
Both of them say you have to have cuts in the military and tax increases to reach balance and so does David Stockton, Ronald Reagen’s supply-side budget director.
Hello?
Yes, Larry, if the bonds are being bought (and they are), that’s taking money away from the private sector – even at rates this low.
I’m not sure what the relevance of the tax rate is here, but they are not at 60-year lows (don’t forget, Clinton raised them in ’93).
I’ve told you what was wrong with the deficit commission – a $900B error you continue to ignore. Once the economy recovers, revenues will return to 19% of GDP, and then we’ll need roughly 1T in reductions.
I’ve also stated, repeatedly, that there are efficiencies to be found in DoD. One day you’ll remember that; I guess today is not that day.
If you are saying that money is chasing treasury notes what does that mean in terms of the non-govt economy?
Is the economy so belly-up that no one wants to put money into the private economy? why?
The Treasury rates are the lowest they have ever been… what more would you do to goose the private economy?
and no.. tax cuts are not the answer guy…
” Tax bills in 2009 at lowest level since 1950″
” Federal, state and local income taxes consumed 9.2% of all personal income in 2009, the lowest rate since 1950, the Bureau of Economic Analysis reports. That rate is far below the historic average of 12% for the last half-century. The overall tax burden hit bottom in December at 8.8.% of income before rising slightly in the first three months of 2010.”
http://www.usatoday.com/money/perfi/taxes/2010-05-10-taxes_N.htm
Why is this important in the context of cutting spending?
because I’ve yet to see any Republican proposal for 1.5 trillion in cuts just nibbling…around the edges and that’s because there is no way to get there from here and they know it and that’s why they are talking billions and not trillions in their “cuts”.
I’m not ignoring the “error”. Are you saying that neither of the commissions have ANY of it correct?
and if you believe this – what is YOUR FIX?
I accept your concurrence on cuts to DOD but no specifics…. what is your number?
How much of the 1.5 trillion would you cut for DOD an then where would the rest come from?
Bonus Question: How much of the 1.5 Trillion is due to Medicare?
If we suddenly and magically fixed Medicare, how much of the 1.5 Trillion would be left to deal with?
Would you be willing to explain the error you see in the deficit commission report again.
thanks!
The Simpson-Bowles Commission set their revenue steady state as 21% of GDP. History shows that the revenue steady state is actually between 18-19%.
By the time S-B finally “balances” the budget, the economy will have grown (by their projections) to the point where 2% of GDP is $900B.
Given that when the economy recovers (and thus revenue gets back to 19% of GDP – it’s about 15% now) the deficit will be somewhere between $900B and $1T anyway, S-B essentially does . . . nothing.
where do you get the 18-19% from? Is that a number commonly accepted by most or demonstrable?
Do you have a reference for the historical data?
Didn’t the other commission report also rely on growth to catch the revenue up?
So you are saying that there are not enough cuts in the two deficit commission reports?
right?
I’m not ragging on you here.. I’m trying to understand your reasoning.. and whether or not it’s reasoning that other economists also point out or if it has a partisan angle to it.
If what you say is true -it would seem to me that the Republicans would have a perfect opportunity to point out that the deficit commission does not do what it claims to do AND for Republicans to show their approach that does (will) work.
I don’t think we can get there with cuts alone but I’m willing to listen to those who say we can if they show how.
It is a commonly accepted percentage. CBO, OMB, and others consider it the norm in their long-term projections, based on data from 1950 forward.
Every commission used growth to have revenues “catch up.” That doesn’t bother me, unless their Revenue % is unrealistic (as I think S-B was). In fact, not only did S-B not have enough cuts; they also included some new spending, IIRC.
It is a very good opportunity for the Ryan-led GOP to present a path to a balanced budget. Whether they will seize it or not, we’ll see.
thanks.
so the enumerated cuts in the deficit commission reports or not enough…. by what.. half?
I would say the cuts need to be about double what the Commission proposed. It would help if they had moved up the retirement age much faster than they recommended.
If GS is correct, there is a simple fix. Borrow another $244 billion rather than cutting $61 bilion and we will add 8% to GDP. That’s about $1.04 trillion. With federal and state taxes govt’s would collect more than that in taxes so we are out of the woods. But wait, we need to borrow another $244 next year and spend it or the GDP will go down $1.04 trillion. Sounds like a never ending cycle. Another thing, if GS is correct and we were able to cut the $1.5 trillion current budget short fall by half it would result in a 25% reduction in GDP ($750 billion/$61 billion x 2%). If we cut it to zero GDP would go down by 50%. Sounds like the federal gov’t is our only hope-not serious. The real question I have for someone that can help me is, the federal gov’t has never run a surplus without a recession following so how do we ever get out of this mess.
[...] Alec Phillips released his inflated-multiplier report on the House Republicans’ budget, I noted the problems with his Old Keynesian [...]