Well…in honor of the fact that the world did not end on Friday, how’s about one of those renowned OTE end-of-the-year features? I’m compiling another CBPPs-greatest-graphs post, but as I’ve been writing something on economics education, I stumbled on a number of economic precepts that have taken a hit over the past year.
Budget Deficits Will Drive up Interest Rates: No, they won’t. Not with the Federal Reserve holding the Fed funds rate at zero and QE bond purchases targeting longer term bond yields. And not with large output gaps in advanced economies and lots of corporate cash on the sidelines (i.e., there’s no case to be made that government borrowing is crowding out private borrowing).
Yet, policy makers continue to be driven by this phantom menace. Of course, for many, attacking deficits is just a tactic to push for spending cuts—“cut social insurance before we’re Greece”! But the simple textbook argument—budget deficits crowd out private borrowing and lead to higher interest rates—has taken a big hit in recent years.
Re Growth, Austerity Works, Keynesian Stimulus Doesn’t: There’s the evidence of actual trends in the UK and Europe, there’s the ongoing slog—slow-growth recovery—here in the US as we’ve pivoted too soon to “negative fiscal impulse” (i.e., diminished fiscal stimulus over time, see figure below—which btw assumes an economically reasonable resolution of the cliff), and there’s solid econometric evidence (see Box 1.1 here). And then there’s the wide-spread economic fears about the fiscal cliff, which are very much Keynesian, driven by the legitimate concern that excessive fiscal contraction will derail the recovery. So perhaps it’s unfair to accuse policy makers of believing that austerity works, though given that many are simultaneously arguing “we must offset the cliff—we must implement large, immediate spending cuts,” I would say that austerity/growth myths persist.
The US Safety Net Doesn’t Work: This is less an argument about economic precepts than conventional conservative wisdom, though some micro-economists (in this case, ones who fail to understand macro) like Casey Mulligan (numerous posts at the NYT) wrongly argue that the safety net has killed recipients’ work ethic.
In fact, the safety net along with progressive taxation (i.e., federal—state systems, not so much)—in such systems, tax burdens automatically fall when incomes go down—have helped to largely reverse income losses to low-income households and keep poverty from rising much at all. Extension of refundable tax credits, food assistance, and unemployment insurance have been particularly important.
The argument that such measures disincentivize work is an old precept of micro-economics and at the heart of on-going critiques. And while there’s definitely something to the critique, as I describe in detail in recent testimony, this is a) an empirical question, and b) such critiques are far weaker in recession (that’s where the macro comes in) when depressed labor demand dominates any behavioral effects. The empirics are clear: an exhaustive study I review in the testimony linked to above finds the American safety net to effectively reduce market-driven poverty and that “…this impact is only negligibly affected by work incentives which, in the aggregate, have almost no effect on the pre-transfer rates of poverty in the population as a whole.”
High Unemployment is Driven by Skills Mismatch: Again, this is mistake driven by a failure to discern structural impacts from cyclical ones. Policy wise, it’s actually a portentous mistake because it allows policy makers to nudge aside weak demand as a key diagnosis and instead blame the unemployed for not having the skills employers need.
–you don’t see it in the wages, i.e., no obvious wage premiums generated by unmet skill demands (though this observation seems least cited in this debate, I find it the most persuasive, especially for economists—if it ain’t in the wages, where is it??!).
–the increase in unemployment has been pretty uniform across occupations and industries suggesting a broad demand shock.
–workers of all types and all skill levels have faced higher unemployment.
–allowing for statistical noise, changes in unemployment have generally been consistent with Okun’s rule related cyclical weakness to higher joblessness.
As I’ve often stressed, however, cyclical could of course morph to structural if it keeps going on for too long—workers’ skills could deteriorate or we could settle into a weaker demand regime with slower growth and less job creation. But most analysts agree that this hasn’t happened yet. All the more reason to try to prevent it.
I’m sure there’s more—like any other, this past year’s been littered with predictions that haven’t come true: Europe will sink us, inflation’s about to bust out, going over the fiscal cliff—even for a minute—will cause a double-dip (OK, calling that wrong is premature, but not by much…). But those are a few of the top of the head…feel free to add others in comments and I’ll collect and maybe post ‘em.