Thursday, June 21, 2012

The "Confidence Fairy" grows teeth

It's more than just a fairy tale.

From MarketWatch
The Business Roundtable on Wednesday said chief executives expect to spend and hire less over the next six months than they previously planned. The group’s economic outlook index fell to 89.1 in the second quarter from 96.9 in the first quarter — the first decline in nine months.
Top executives are increasingly worried about potentially big changes in U.S. tax and spending policies in 2013— the so-called fiscal cliff — as well as the spillover effects of the financial crisis in Europe.
The Roundtable’s chairman, Boeing (US:BA) CEO Jim McNerney, said all the uncertainty is causing “paralysis” among businesses as the end of the year approaches. Some are even cutting jobs until they have a clearer idea of how the fiscal cliff and European crisis will be resolved.
“”We are being forced to trim employment in some places. A number of companies are doing that,” said McNerney, who is also a member of President Obama’s council on jobs...
McNerney say it’s harder for companies to make plans for hiring and capital spending unless they know what the tax rates will be. On the spending side, defense firms could be at risk since the cuts would largely take place in the military’s budget.

Paul Krugman has steadfastly maintained that talk of austerity during a recession is the real problem, and business confidence is a non-issue in today's economic climate. 

What to make of this news report, then? Top CEOs of American companies are warning that their spending and hiring decisions are affected by future changes to tax and fiscal policies. If this isn't the confidence fairy working its evil magic, what else is it?

Of course, maybe the CEOs of Walmart, GE, AT&T, and ExxonMobil don't possess the economic wisdom of Paul Krugman. Maybe their statements are just a crass smokescreen over the corporate policies they'd choose anyway, and all this talk of "fiscal cliffs" is just a convenient excuse. Maybe.

The federal government spent $3.2 trillion in 2009, $3.55 trillion in 2010, and $3.83 trillion in 2011 (compared to a miserly $2.7 trillion in 2006). In other news, today the Fed predicts unemployment will remain above 8% for the rest of the year. But maybe we just need to stimulate aggregate demand a little bit more.

Government spending rose 7% between 2010 and 2011 but the economy grew at about a third of that rate. Either the multiplier is a myth, or businesses/individuals are offsetting their spending now to account for higher tax rates implied by current spending (the Ricardian Equivalence argument)... or both.

So who are you going to trust: the Keynesians, or your own lying eyes?

3 comments:

  1. "Boeing (US:BA) CEO Jim McNerney, said all the uncertainty is causing “paralysis” among businesses as the end of the year approaches. Some are even cutting jobs until they have a clearer idea of how the fiscal cliff and European crisis will be resolved.
    “”We are being forced to trim employment in some places. A number of companies are doing that,” said McNerney, who is also a member of President Obama’s council on jobs..."


    "What to make of this news report, then? Top CEOs of American companies are warning that their spending and hiring decisions are affected by future changes to tax and fiscal policies. If this isn't the confidence fairy working its evil magic, what else is it?"

    $21 billion of $68 billion of Boeing's revenue comes from government contracts. If we're worried about the deficit, then it makes sense that such contractors that are heavily dependent on the government should take the hit, unless we're Keynesians who believe that government spending creates jobs. Moreover, if demand for these firms' products is uncertain in 2013, why reduce output now by cutting jobs when people are buying their products? It could be that these CEOs are trying to scare the government into giving them the money and tax breaks they want.

    "The federal government spent $3.2 trillion in 2009, $3.55 trillion in 2010, and $3.83 trillion in 2011 (compared to a miserly $2.7 trillion in 2006) … Government spending rose 7% between 2010 and 2011 but the economy grew at about a third of that rate."

    You might want to recheck these numbers. Federal spending as a share of GDP has dropped since 2010:
    http://research.stlouisfed.org/fred2/graph/?g=89H"

    Also, Krugman includes local government spending when discussing the failure of austerity policies.
    http://research.stlouisfed.org/fred2/graph/?g=89J

    It appears government is shrinking, not expanding.

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    Replies
    1. While Boeing is a part of the group quoted in that article, it overall represents "companies with more than 14 million employees and $6 trillion in annual sales." I'm guessing most of those are more worried about consumer sales than influencing government to give them more breaks.

      The reason to cut employment now before consumption falls is probably because the firing process takes time, given the possibility of wrongful termination lawsuits and so on. Companies realize they can lay people off now and if they decide to ramp up production, rehire them... but they wouldn't feel the need to do that if demand seemed sustainable currently.

      Re: federal spending. I pulled numbers from 2010 and 2011 off Wikipedia. After re-checking, I find (in trillions):
      2009: $3.518
      2010: $3.721
      2011: $3.63
      (in 2011, I confused requested with enacted... oops. Silly mistake.)

      Taken in the very short term, maybe it appears government is shrinking. But compared to just 5 years ago, it's a huge increase. Why haven't we seen a corresponding surge in growth?

      Measuring in terms of spending/GDP is somewhat deceptive, because GDP is growing (albeit slowly). Relative to 2009 and emergency spending done then, federal spending has dropped, but relative to any past point in our history, we're still at record highs. If the multiplier were working, we'd be free and clear by now.

      It seems the Keynesian medicine has been tested and it isn't giving much of a cure. Maybe the recession "would have been worse" without that spending... but then we're back to debates about falsifiability.

      When talking about local government spending, Tyler Cowen has a relevant recent NYT article on the subject. People on the state/local level are feeling less rich, so they've cut back on public spending. Do we say those people are just irrational and need to have their mistake corrected by all-knowing federal policymakers, or could it be that federal spending is out of touch with what the nation really feels like it can afford?

      Overall I think it points to the Ricardian Equivalence story: higher spending now implies higher taxes later, so people decide to save instead of spending the money they take in. Restoring confidence in the economy (i.e. the belief that there is more than government fiscal policy supporting it) will be a prerequisite to robust growth.

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    2. Sure the Boeing CEO was the representative of the group, but his opinions are useful in this context. His is a business that straddles the public and private sectors, so his position tells us something about the confidence fairy. If he believes in it, then Boeing should do just fine losing its government contracts because less government spending should restore his confidence in building commercial airliners. If Boeing needs the contracts to maintain its revenue, then it's the beneficiary of Keynesianism, if militarized.

      "Taken in the very short term, maybe it appears government is shrinking. But compared to just 5 years ago, it's a huge increase. Why haven't we seen a corresponding surge in growth?"

      Given that the velocity of M2 is at a record low, there has been no surge in spending overall.

      http://research.stlouisfed.org/fredgraph.png?g=8b7

      "Measuring in terms of spending/GDP is somewhat deceptive, because GDP is growing (albeit slowly). Relative to 2009 and emergency spending done then, federal spending has dropped, but relative to any past point in our history, we're still at record highs. If the multiplier were working, we'd be free and clear by now."

      So what if government spending is at a record high? Government spending is usually at a record high, which is why it needs to be compared to something to make useful claims about it. For example, government consumption and investment are dropping relative to all private sector activity. There was relatively more government spending in the 1980s than right now.

      http://research.stlouisfed.org/fredgraph.png?g=8b8

      As for the multiplier, two economists did a study on the stimulus and found a multiplier of 0.5 to 1.0, which doesn't seem very high to me.

      "It seems the Keynesian medicine has been tested and it isn't giving much of a cure. Maybe the recession "would have been worse" without that spending... but then we're back to debates about falsifiability."

      Keynesianism is falsifiable, all one has to do is show that government spending either vanishes once it's spent, or that the short term employment boost that it creates can't be sustained without government spending. In other words, once the spending stops, everyone is unemployed again and the remaining workers have more public debt to pay from their income.

      "Do we say those people are just irrational and need to have their mistake corrected by all-knowing federal policymakers, or could it be that federal spending is out of touch with what the nation really feels like it can afford?"

      If "correcting their mistake" means creating jobs for people who the private sector is not employing, then yes. Just because people think government spending produces nothing other than debt doesn't mean we should indulge that belief.

      "Overall I think it points to the Ricardian Equivalence story: higher spending now implies higher taxes later, so people decide to save instead of spending the money they take in. Restoring confidence in the economy (i.e. the belief that there is more than government fiscal policy supporting it) will be a prerequisite to robust growth."

      Ricardian equivalence has less to do with "high spending" and more to do with whether the government is running a deficit. As of now, the federal deficit/GDP is only slightly worse than in the mid-1970s but it's improving. Why wasn't there a Ricardian equivalence problem during the Reagan era or the Bush II era? Shouldn't everyone have stopped spending when the Iraq War began because they "knew" they'd be paying higher taxes in the future?

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