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Posted at 5:55 PM ET, 03/ 1/2011

What do John Taylor and Mark Zandi disagree about?

By Ezra Klein

Mark Zandi says the GOP's proposed spending cuts will cost about 700,000 jobs. John Taylor says they will "increase economic growth and employment." Both are respected economists who immerse themselves in data, research and theory. So how can they disagree so sharply?

The dispute comes down to how much weight you give to "expectations" about future deficits. Taylor's argument is that Zandi's model -- which you can read more about here -- doesn't account for the upside of deficit reduction -- namely, that when the government spends less, the private sector will spend more. Taylor thinks individuals and businesses are hoarding their money because they're afraid of the high taxes, sharp spending cuts and assorted other nastiness that deficit reduction will eventually require. "The high unemployment we are experiencing now is due to low private investment rather than low government spending," he writes. "By reducing some uncertainty and the threats of exploding debt, the House spending proposal will encourage private investment."

Zandi doesn't buy it. "That kind of thinking does probably play some role," he says, "but I don't think it's broadly applicable to most of the population. And even for higher-income, wealthy households who would be particularly likely to respond like that, I'm having trouble seeing it. Most of the improvement in spending in recent years has come among those high-income groups."

For Zandi -- and others, such as Goldman Sachs, who agree with his basic model -- businesses aren't holding back because of deficits. They're holding back because sales are weak and they show little sign of getting stronger. And there's no reason to hire a new employee if sales aren't going to go up. If the public sector then fires a few hundred thousand workers, that doesn't mean more customers for businesses -- it means fewer. And that, in turn, means that they will expect lower sales and continue to hoard their cash.

Their dispute is empirical as well as theoretical. "The stimulus package of 2009 had no material positive effect on economic growth or employment," Taylor writes. Zandi couldn't disagree more: "The recession ended in precisely the same month that the stimulus spendout was at its maximum point, which was June of 2009," he says. "The stimulus ended the recession."

As readers might guess, I come down on Zandi's side of the argument. I've had a lot of trouble finding evidence -- or even a consistent articulation -- of the argument that policy or short-term deficit uncertainty has restrained private investment. At the same time, the spending cuts being pushed by the House GOP do much less to improve the deficit than the tax cuts being pushed by the House GOP do to worsen it -- but those are tax cuts that Taylor has long supported. Finally, we know what it looks like when public borrowing is crowding out private spending. And we're just not seeing it.

There's another question as to why Goldman Sachs and Mark Zandi are estimating that the GOP's spending cuts will do much more harm to the economy than Fed Chairman Ben Bernanke is -- but note that unlike Taylor, Bernanke agrees that the immediate effects of the spending cuts will be to reduce growth.

By Ezra Klein  | March 1, 2011; 5:55 PM ET
Categories:  Economics  
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Comments

So what does this tell you about the science of economics when an economist call be well respected and formulate ideologically driven conclusions which you can't find evidence for?

Posted by: DDAWD | March 1, 2011 6:05 PM | Report abuse

Taylor is obviously right since he was clever enough to invent the term "crowd in" when his argument that government spending today is "crowding out" private investment was laughed out of the room.

I don't know who's right, but it's actually pretty pathetic that economists can't even tell us what to do in a crisis. Basically other than teaching their students to be greedy they don't seem to know anything useful.

Posted by: Hopeful9 | March 1, 2011 6:06 PM | Report abuse

The small business community, as surveyed by the NFIB, continues to say that poor sales is more of a concern to them than taxes or government regulations and red tape. That would tend to lend more credence to Zandi's argument.

The January survey is here: http://www.nfib.com/Portals/0/PDF/sbet/sbet201102.pdf

The results of the "single most important problem" were: poor sales 27%, taxes 19%, red tape 17%.

Posted by: victor-ny | March 1, 2011 6:17 PM | Report abuse

On the bright side, if both are right, the proposed fiscal realignment simply eliminates the job gains provided by the PPACA.

For those who've forgotten, last year at this time we were told how the PPACA would solve all joblessness problems. It didn't.

Posted by: rmgregory | March 1, 2011 6:25 PM | Report abuse

Get out of Iraq and Afghanistan and/or raise taxes minimally on the top 2% of income earners. Problems solved.

Posted by: jillcohen | March 1, 2011 6:41 PM | Report abuse

Of course Zandi is right. Taylor has tripped over the Ricardian equivalence fallacy ("Ricardo, in expanding his treatment of this subject for an Encyclopedia Britannica article, changed so many features of it as to result in a Ricardian Nonequivalence Theorem").
http://en.wikipedia.org/wiki/Ricardian_equivalence

Posted by: beowulf_ | March 1, 2011 6:57 PM | Report abuse

No way that limited spending cuts can stimulate the economy. After GOP proposed cuts we still will have trillion plus deficits.

Posted by: lauren2010 | March 1, 2011 7:19 PM | Report abuse

The investment component of GDP consists of residential real estate, non-residential real estate, equipment and software and change in private inventories. In 2010, investment in equipment and software increased 15%. You have to go all the way back to 1984 to find higher growth. Residential contracted 3% and non-residential contracted 13%. Real estate investment is contracting because there is still excess inventory, not because deficits are large. Interest rates are very low. If business had a need to invest in real estate, they would do it. They are not doing it because there is no need for it, not because they are worried about the deficit.

Investment grew 16% in 2010 after contracting 22% in 09. The problem isn't weak investment. Demand for services is 47% of GDP and it only grew .5% last year.

Posted by: JIMMYJONES | March 1, 2011 7:21 PM | Report abuse

"And that, in turn, means that they will expect lower sales and continue to hoard their cash."

How many times does it need to be said? Businesses are NOT hoarding "cash". That "cash" is primarily short term debt (such as money market funds), a good chunk of it from the federal government's stimulus efforts. You see, if the government borrows $100 from a private company, an observer might note that company sitting on $100, but that's just a T-bill - the money has already been spent. Even cash in the bank isn't hoarded - it is being used to fund loans.

"Finally, we know what it looks like when public borrowing is crowding out private spending. And we're just not seeing it."

The crowding out is visible in the hoard of "cash". Corporations don't keep paper bills under the mattress.

"The stimulus ended the recession."

Um, pretty much all of the decline in RGDP (and all of NGDP) ended in Dec2008 per Macroadvisers. Just sayin'. Go look at a chart of retail sales - they bottomed in December.

http://www.census.gov/retail/

Why didn't we have a strong recovery? Historically, every deep downturn, including the Great Depression, saw a bounce in activity after it was over. Why was real final sales growth in the first six quarters of this 'recovery' slower (+0.93% 09Q2-10Q3) than we experienced in the 2001 'recession' (+1.13%, 01Q1-01Q3)?

http://www.themoneyillusion.com/?p=7581

What ended the 1920 Depression?

Take a look at the following data. Government spending fell like a brick from 1919 to 1922, yet real GDP rose. Look at the 1916 to 1919 data too. Does it look like federal spending has positive multipliers on private spending?

From 1920 to 1923, federal spending fell from $52.77 billion to $34.91 billion. GDP rose from $687.7 billion to $802.6 billion.

Change the data to total spending. Essentially zero real growth in government spending from 1920-1923, and yet the recovery was rapid.

http://usgovernmentspending.com/downchart_gs.php?year=1910_1930&view=1&expand=&units=k&fy=fy12&chart=F0-fed&bar=1&stack=1&size=m&title=&state=US&color=c&local=s

"There's another question as to why Goldman Sachs and Mark Zandi are estimating that the GOP's spending cuts will do much more harm to the economy than Fed Chairman Ben Bernanke is"

Isn't it obvious? Mainstream economic theory holds that the Fed can offset any demand shock from lower government spending via monetary policy. Even if he thought fiscal austerity was highly contractionary, Bernanke could launch QE3 and offset it.

Fiscal multipliers more or less don't exist under an inflation targeting central bank.

Posted by: justin84 | March 1, 2011 7:29 PM | Report abuse

Zandi is ok, but not exactly brilliant with his predictions. I was watching CNBC late last fall when the one monthly unemployment number came in that was an outlier, I think it was the 9.6 one. He was very confident on air that we were heading to 10% unemployment, which turned out to be be competely untrue of course.

Posted by: johnmarshall5446 | March 1, 2011 7:34 PM | Report abuse

"The results of the "single most important problem" were: poor sales 27%, taxes 19%, red tape 17%."

Of course, had the survey substituted "government" for taxes and red tape, government would be the single largest problem, at 36%. Actually, it would be 41% if you tossed in inflation, and 46% if you included quality of labor (at least a portion of which is arguably the result of government action).

While poor sales is a problem, how does it help to have the government temporarily create more sales? Poor sales will again be a problem as soon as the stimulus ends. The market requires sustainable patterns of activity, not a temporary splash of government spending.

By the way, I find it interesting that 28% cited "few or no qualified applicants" for job openings - not much different from 40% 5 years ago, and 13% have positions that they can't fill.

Posted by: justin84 | March 1, 2011 7:46 PM | Report abuse

-------------While poor sales is a problem, how does it help to have the government temporarily create more sales? ----------------
1) Because it ends the recession, people stop being panicked, confidence increases, and people start spending again which solidifies the gains. Which results in higher sales and continued growth.
2) Because government investments will save consumers/people money in the long run resulting in more income that can be used to create more sales. An example is weatherizing homes which for ever dollar spent results in $2500 in savings over periods of ten years. There are plenty of other examples including updating health care technology, investments in head start, increasing energy standards/efficiency, and public transportation in heavily congested locations.
3) Temporary increases in sales will increase human well being during a time when human well being is at its lowest.
4) During a recession is the best time for government to do infrastructure spending because A) interest rates are low, B) There are millions of unemployed workers, and unused resources/plants and C) inflation pressures are non-existent.

Posted by: mynameisblehbleh | March 1, 2011 8:14 PM | Report abuse

TARP was part of the stimulus and it started in October, 2008, and the fact that Americans believed the gvmt was acting to stop the recession from becoming worse no doubt had some impact on confidence.

What started the depression? Hoover.

What ended it? FDR and WWII.

99% of economists agree with a basic and often annunciated depression narrative, and any attempt today to pretend that any thing other than massive gvmt spending and WWII and post-WWII global dominance of American manufacturing is revisionism.

GOP spending cuts are negligible and will still result in trillion dollar plus deficits. The GOP is merely HOPING for some kind of 2012 bounce so they can claim modest cuts helped and therefore provide a narrative for more massive cuts after 2012 after they win the WH and Senate.

Neither party now is doing anything audacious to aid the economy, but they are doing things that could hurt it.

Walker alone proposed to cut 22,000 jobs, so right there we have 3% downpayment just today on that 700,000 job loss.

Posted by: lauren2010 | March 1, 2011 8:28 PM | Report abuse

-------The crowding out is visible in the hoard of "cash". Corporations don't keep paper bills under the mattress.-----
Corporations aren't hoarding any more "cash" then they were 2, 3, or 5 years ago. So how can this crowding out occur when corporations aren't hoarding any more "cash" then they usually do?

------"The stimulus ended the recession."
Um, pretty much all of the decline in RGDP (and all of NGDP) ended in Dec2008 per Macroadvisers. Just sayin'. Go look at a chart of retail sales - they bottomed in December.-----------
Retail sales doesn't equal GDP.
In the first quarter of 2009 GDP decreased by 4.9%. The bottom is the lowest spot.

-------------Why didn't we have a strong recovery? Historically, every deep downturn, including the Great Depression, saw a bounce in activity after it was over?------------
The 1990's and 2000's recessions didn't have a particular high recovery. And historically most recessions don't contain a huge financial crisses and a real estate bust.

------------- Government spending fell like a brick from 1919 to 1922, yet real GDP rose. Look at the 1916 to 1919 data too. -----------------
You ever hear of ww1?

.-------Change the data to total spending. Essentially zero real growth in government spending from 1920-1923, and yet the recovery was rapid.----------

I don't think it is honest to claim that 1920-1923 was a recovery from a recession when the last recession occurred 7 years prior.

----------- Mainstream economic theory holds that the Fed can offset any demand shock from lower government spending via monetary policy.------------
Not when the money the FED releases is held, or used to cover prior debt instead of being spent.


Posted by: mynameisblehbleh | March 1, 2011 8:39 PM | Report abuse

There are several comments to the effect that discipline--I won't say "science"--of economics must be in pretty poor shape when two "respected economists" come to such different conclusions. There actually isn't that much disagreement among the practicing mainstream--I will define that as people who are actually paid for the accuaracy of their forecasts. (I speak as someone who is paid, and handsomely, to do just that.) Zandi represents the mainstream; Taylor stands far outside of it. Goldman Sachs's take is par for the course among Wall Street firms. You would get much the same answer from economists at the Fed, the IMF, OECD, or CBO. Wall Street and those organizations are the gold standard for practical forecasting. Taylor is, not to put too fine a point on it (and although an academic economist responsible for some pretty important contributions), a right-wing hack. He will always spout the American Enterprise Institute party line, regardless of what the data say. What's more, it's well known that his staff at Treasury (when he was Undersecretary for International Affairs) regarded him as extraordinarily clueless about practical policymaking. The point isn't so much that Taylor is dishonest: I can't say or judge that. It's that an extreme form of right-wing dogma, not empirics or evidence, determines what he will say about any given policy.

Posted by: madhoboken | March 1, 2011 9:59 PM | Report abuse

It would be interesting to hear John Taylor's explanation of why Britain and Germany are both losing growth in the wake of their austerity measures.

Posted by: Lee_A_Arnold | March 1, 2011 10:20 PM | Report abuse

Here's what Jodi Beggs (Harvard econ Ph.D. student) of the "Economists do it with Models" blog said about Taylor's argument, which is called called Ricardian equivalence:

"Given that many people seem barely able to even say what country the U.S. declared its independence from, I am not so concerned with such sophisticated and forward-looking behavior occurring on a large scale."

at: http://www.economistsdoitwithmodels.com/2010/07/07/dear-jon-stewart-economists-are-happy-to-tell-you-about-unemployment-so-locking-us-in-closets-is-not-needed/

And here's Paul Krugman:

Does this argument sound convincing? It did (and still does) to many economists. Akerloff pointed out, however, that it depends critically on the assumption that people do something that they are unlikely to do in real life: take account of the implications of current government spending for their future tax liabilities. That is, the claim that deficits don't matter implicitly assumes that ordinary families sit around the dinner table and say, "I read in the paper that President Clinton plans to spend $150 billion on infrastructure over the next five years; he's going to have to raise taxes to pay for that, even though he says he won't, so we're going to have to reduce our monthly budget by $12.36."

...the truth is that even families of brilliant economists don't have conversations like this. No, the point is that the effort isn't worth it. If a family has arrived at a sensible rule of thumb for deciding how much to spend, trying to improve on that rule by making sophisticated predictions about the future implications of government spending will improve the families decisions so little that it isn't worth the investment of time and attention.

– "Peddling Prosperity", 1994, page 208.

Ricardian equivalence is an interesting idea to think about, and perhaps a small number of people think somewhat like this, so perhaps it's some minor force in the economy, but to think it happens on a large scale is to make some wild assumptions about the reality I've experienced and read about over a lifetime. To put together a chain of logic that it is not common requires anchoring to just really mild assumptions, much milder than even those depended on even in typical econometric tests.

Posted by: RichardHSerlin | March 1, 2011 11:18 PM | Report abuse

Oh, THANK G0D that Ezra Klein is here to weigh in for us on the dispute, and clarify that (shock! shock!) Zandi is most likely the right one! Where would we be without Ezra's steel-trap intellect to straighten things out for us?

Posted by: lejardin | March 2, 2011 12:52 AM | Report abuse

lejardin

No one is twisting your arm to read this blog. You obviously feel Ezra's activities are some kind of threat to your dogma, otherwise why else be here if you don't agree with anything he says?

Indeed, most of the anti-klein commenters here aren't here to learn anything, but rather to sabotage, as per the Republican SOP.

Posted by: lauren2010 | March 2, 2011 7:05 AM | Report abuse

"Corporations aren't hoarding any more "cash" then they were 2, 3, or 5 years ago. So how can this crowding out occur when corporations aren't hoarding any more "cash" then they usually do?"

If you believe that, go tell Klein & Co, and provide data. Liberals have all been claiming that corporations are hoarding cash. As far as I can tell, no one has shown they've gotten the general claim wrong, only the analysis of the claim.

http://www.hussmanfunds.com/wmc/wmc100809.htm

The truth of the matter is that stimulus *requires* someone to hold the debt, and that often looks like someone is sitting on cash. It could be China. You don't need any fancy notions like Ricardian Equivalence either - the creation of debt securities requires someone to buy them. Those people aren't going to be doing whatever else they would have done with the money otherwise.

"In the first quarter of 2009 GDP decreased by 4.9%. The bottom is the lowest spot."

Macroadviser's monthly GDP data have the recession largely ending in December. 2009Q1 was a sharp drop because rapid declines in 2008Q4 put the 2009Q1 monthly average well below 2008Q4. Check out the money illusion link I provided.

By the way, the economy shrank in 2009Q2 too, again using quarterly averages. Nearly all of the actual output loss of the recession was from June to December, measured on a monthly basis.

In addition, the stimulus wasn't the only thing going on. The Fed was very active, mark to market accounting was suspended, inventories were being successfully worked down before ARRA even started spending money - all of those are important factors you must account for. On top of that, recessions all end naturally by themselves. If you start stimulating over a year into a recession, there's a decent chance it will look well timed, as most recessions don't last very long.

"You ever hear of ww1?"

Yes, I've heard of it. Why didn't all that government spending stimulate the private sector? The private sector completely collapsed.

"I don't think it is honest to claim that 1920-1923 was a recovery from a recession when the last recession occurred 7 years prior."

Actually, the recession was from 1920-1921 - and it was somewhat more severe than 2007-2009 but otherwise quite similar (same duration, starting and ending around the same time of year, deflationary, etc).

Unemployment in 1921 was estimated to have reached 2009 levels, and by 1923 it was lower than anytime since World War II.

"Not when the money the FED releases is held, or used to cover prior debt instead of being spent."

The Fed can always increase AD in mainstream economic theory if it wants to. It's difficult to imagine that the creation of significant quantities of new money can be less stimulative than shuffling money around from one use to another, which is what stimulus is. Even Zimbabwe's central bank created AD in a depressed economy.

Posted by: justin84 | March 2, 2011 8:01 AM | Report abuse

Moody's vs. Stanford? Hmmm.

Posted by: marteen | March 2, 2011 4:24 PM | Report abuse

Right wing economist says cut spending and cut taxes and that will fix everything.

God why does that type of rigid stupidity even have to be debated. America lose more IQ points daily than they are gaining.

Posted by: LosGatosCA | March 4, 2011 12:01 AM | Report abuse

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