Musings on Economics from a non-Economist

I never studied economics in school, but I guess you could call me an amateur macro-economist now.  Or perhaps a pretend economist.  Anyway, the study of large economies interests me, and I'm particularly struck by the challenge of evaluating a particular government action or policy in light of the fact that so many things are happening at the same time.  How can we say that government stimulus worked in 2008-2009, when at the exact same time the Fed was doing all kinds of stuff, and taxes were being cut, and a new president was being elected, etc etc?

Compounding this, as my friend "N" keeps reminding me in our email correspondence, is the reality of confirmation bias.  It is built into our nature to look for evidence to support our preconceptions, rather than to follow the evidence wherever it leads.  When I'm surfing the net looking for politics articles to read, I am much quicker to click on headlines that confirm something I already believe than on a headline that challenges that belief.  Now I believe some people are more hung up on confirmation bias than others, and as a seeker of Truth it is the duty of all of us to fight against our tendencies in this area.

Anyway, when it comes to macroeconomics during modern times, the questions that are asked are these:

• Does Keynesian stimulus work?
• Do tax cuts make a significant difference in growth?
• When a central bank can't reduce interest rates any more, will "printing money" help the economy or will it cause inflation?

There are lots more of course, but I want to take the first two of these.

Does Stimulus Work?

We had a recent financial crisis and bad recession, which turned out to be worldwide.  In response in the US, the Obama administration pushed through stimulus measures in 2009 to save the economy from a bigger collapse.  Conservatives, who had previously loved stimulus, have grown much more conservative of late, and now pushed hard for Hooverite budget balance in the face of the recession.  As a result, a stimulus package (including spending hikes as well as tax cuts- both of those are stimulus measures) was passed in 2009, but it was smaller than liberal economists calculated was needed.  We then proceeded to get out of the recession in due time, but haven't had the kind of job growth we need to return to previous trends.  In other words, we've had a recovery (so it worked!) but the recovery has been disappoining (so it failed!).  We did stimulus (we tried it and it failed!), but that stimulus was too small to get us back to speed (we never really tried it!).

So how to measure whether stimulus worked? I think what makes the most sense, since the crisis was worldwide, is to look at similar places to ours and compare policy and outcomes.  That makes a good case for stimulus: in Europe they did much less stimulus than we did in the US and their continent-wide problems are much worse than the US right now.  Of course, those problems are really bad in particular countries (Greece, Spain, Ireland, Italy), while in Germany things are going much better even though not much stimulus happened.  I think this is still a good case for stimulus though, as looking at Germany in isolation is kind of like looking at Massachusetts in isolation- they're part of a large monetary union, with stronger parts and weaker parts.  But others will point out that Euro area countries set lots of their own policies, and are separate entities much more than US states are, which is certainly true.

So there's still enough doubt about stimulus that sceptics won't be convinced.  BUT there's one thing I think you can say: US-style stimulus did not do any harm.  Interest rates remain low so borrowing is easy.  The stimulus program is over now, so there are not ongoing costs.  There was no double-dip recession.  European countries that stopped stimulus and tried to balance budgets earlier than us (like the UK) are doing much worse.  Maybe we can't prove the positive value of stimlus to a scepic's liking, but we certainly proved that their forecasts of doom from overspending was wrong.

Are high taxes stifling the economy?

I find the Republican fetish for tax cuts almost comical at this point.  It seems like their answer to any question is "tax cuts!".  But look at recent history:

• Taxes were cut way back by Reagan in his first term.  The economy did well, perhaps as a result of this, but the federal deficit ballooned. 
• In his second term and in the term of George HW Bush, taxes were increased (though never to the level they were in the 1970s).  The economy boomed in the 1990s.
• Under Clinton taxes were increased again; the economy boomed and the federal budget was in surplus by 2000.
• Under George W Bush, taxes were cut precipitously.  The economy performed sort-of OK from 2002 to 2007, growing but producing fewer jobs than most recoveries in the modern era. Then a financial crisis completely destroyed what little growth there had been (I blame the financial crisis on banking policy, not on tax rates; but those low taxes obviously didn't do much to push back against the crisis).
• In 2013 taxes were finally increased again, after a five year period of historically low taxes (the Bush tax cuts plus the stimulus tax cuts including social security tax cuts, passed by Obama).  So far in '13, the economy as a whole seems unaffected, continuing its recent growth.  Still growing, but not really fast enough.

Does this prove that higher taxes, particularly on the wealthy, are great for the economy?  No- Federal Reserve policy matters a lot, and I guess regulatory policy matters too.  But what is proved pretty clearly is that tax cuts are not the magic answer to all our economic questions.  Tax cuts probably goose the economy somewhat- but the Bush tax cuts definitely did not bring us the benefits that we were told it would.


So I guess in economics it's easier to prove negatives than positives.