Archive for the ‘Macroeconomics’ Category

The House recently changed the rules of budget scoring: The Congressional Budget Office and the Joint Committee on Taxation will now account for macroeconomic effects when estimating the budget impacts of major legislation. Here are three things you should know as we await the first official dynamic score.

1. Spending and regulations matter, not just taxes

You might think dynamic scoring is just about taxes. It’s not. Spending and regulatory policies can also move the economy. Take the Affordable Care Act. CBO estimates that the law’s insurance subsidies will reduce labor supply by 1.5 to 2.0 percent from 2017 to 2024, some 2 to 2.5 million full-time equivalent workers. If CBO and JCT do a dynamic score of the House’s latest ACA repeal, this effect will be front and center.

The same goes for immigration reform. In 2013 (and in 2006), CBO and JCT included some macroeconomic effects in their score of comprehensive immigration reform, though they did not do a fully dynamic score. Under today’s rules, reform would show an even bigger boost to the economy and more long-term deficit reduction than the agencies projected in the earlier bills.

2. Dynamic scoring isn’t new

For more than a decade, CBO and JCT have published dynamic analyses using multiple models and a range of assumptions. For example, JCT projected former House Ways & Means Committee chairman Dave Camp’s tax reform plan would boost the size of the economy (not its growth rate) by 0.1 to 1.6 percent over 2014 to 2023. The big step in dynamic scoring will be winnowing such multiple estimates into the single set of projections required for official scores.

Observers understandably worry about how the scorekeepers will do that. For example, what will JCT and CBO do with certain forward-looking models that require assumptions not just about the policy in question but also about policy decisions Congress will make in the future? If the agencies score a tax cut today, do they also have to include future tax increases or spending cuts to pay for it, even if Congress doesn’t specify them? If so, how should the agencies decide what those offsetting policies are? Does the existence of such models undermine dynamic scoring from the start?

Happily, we already have a good sense of what the agencies will do, and no, the existence of such models doesn’t hamstring them. At least twice a year, CBO and JCT construct baseline budget projections under existing law. That law often includes scheduled policy changes, most notably the (in)famous “fiscal cliff” at the end of 2012. CBO and JCT had to include the macro effects of the cliff in their budget baseline at that time, even though they had no idea whether and how Congress might offset those policies further in the future. That’s dynamic scoring in all its glory, just applied to the baseline rather than analyzing new legislation. CBO and JCT didn’t need to assume hypothetical future policies to score the fiscal cliff, and they won’t need to in scoring legislation either.

3. Dynamic scoring won’t live up to the hype, on either side

Some advocates hope that dynamic scoring will usher in a new era of tax cuts and entitlement reforms. Some opponents fear that they are right.

Reality will be more muted. Dynamic scores of tax cuts, for example, will include the pro-growth incentive effects that advocates emphasize, leading to more work and private investment. But they will also account for offsetting effects, such as higher deficits crowding out investment or people working less because their incomes rise. As previous CBO analyses have shown, the net of those effects often reveals less growth than advocates hope. Indeed, don’t be surprised if dynamic scoring sometimes shows tax cuts are more expensive than conventionally estimated; that can easily happen if pro-growth incentives aren’t large enough to offset anti-growth effects.

Detractors also worry that dynamic scoring is an invitation for JCT or CBO to cherry pick model assumptions to favor the majority’s policy goals. Doing so runs against the DNA of both organizations. Even if it didn’t, the discipline of twice-yearly budget baselines discourages cherry picking. Neither agency wants to publish rosy dynamic scenarios that are inconsistent with how they construct their budget baselines. You don’t want to forecast higher GDP when scoring a tax bill enacted in October, and have that GDP disappear in the January baseline.

I am cautiously optimistic about dynamic scoring. Done well, it can help Congress and the public better understand the fiscal effects of major policies. There are still some process issues to resolve, most notably how investments might be handled, but we should welcome the potential for better information.

For more views, see the dynamic scoring forum at TaxVox, the blog of the Tax Policy Center.

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Yesterday, the Federal Reserve confirmed that it would end new purchases of Treasury bonds and mortgage-backed securities (MBS)—what’s known as quantitative easing—in October. In response, the media are heralding the end of the Fed’s stimulus:

“Fed Stimulus is Really Going to End and Nobody Cares,” says the Wall Street Journal.

“Federal Reserve Plans to End Stimulus in October,” reports the BBC.

This is utterly wrong.

What the Fed is about to do is stop increasing the amount of stimulus it provides. For the mathematically inclined, it’s the first derivative of stimulus that is going to zero, not stimulus itself. For the analogy-inclined, it’s as though the Fed had announced (in more normal times) that it would stop cutting interest rates. New stimulus is ending, not the stimulus that’s already in place.

The Federal Reserve has piled up more than $4 trillion in long-term Treasuries and MBS, thus forcing investors to move into other assets. There’s great debate about how much stimulus that provides. But whatever it is, it will persist after the Fed stops adding to its holdings.

P.S. I have just espoused what is known as the “stock” view of quantitative easing, i.e., that it’s the stock of assets owned by the Fed that matters. A competing “flow” view holds that it’s the pace of purchases that matters. If there’s any good evidence for the “flow” view, I’d love to see it. It may be that both matter. In that case, my point still stands: the Fed will still be providing stimulus through the stock effect.

P.P.S. I wrote about this last year during the tapering debate. In the lingo of that post, the Fed is moving from quantitative easing to quantitative accommodation. To actually eliminate the stimulus, the Fed would have to move on to quantitative tightening.

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Because macroeconomists have messed it up for every one else , says Noah Smith at The Week:

To put it mildly, economists have fallen out of favor with the public since 2008. First they failed to predict the crisis, or even to acknowledge that such crises were possible. Then they failed to agree on a solution to the recession, leaving us floundering. No wonder there has been a steady flow of anti-economics articles (for example, this, this, and this). The rakes and pitchforks are out, and the mob is ready to assault the mansion of these social-science Frankensteins.

But before you start throwing the torches, there is something I must tell you: The people you are mad at are only a small fraction of the economics profession. When people in the media say “economists,” what they usually mean is “macroeconomists.” Macroeconomists are the economists whose job is to study business cycles — booms and busts, unemployment, etc. “Macro,” as we know it in the profession, is sort of the glamor division of econ — everyone wants to know whether the economy is going to do well or poorly. Macro was what Keynes wrote about, as did Milton Friedman and Friedrich Hayek.

The problem is that it’s hard to get any usable results from macroeconomics. You can’t put the macroeconomy in a laboratory and test it. You can’t go back and run history again. You can try to compare different countries, but there are so many differences that it’s hard to know which one matters. Because it’s so hard to test out their theories, macroeconomists usually end up arguing back and forth and never reaching agreement.

Meanwhile, there are many other branches of economics, doing many vital things.

What are those vital things? Some economists find ways to improve social policies that help the unemployed, disabled, and other vulnerable populations. Others design auctions for Google. Some evaluate development polices for Kenya. Others help start-ups. And on and on. Love it or hate it, their work should be judged on its own merits, not lumped in with the very different world of macroeconomics.

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A tribute to Ben Bernanke, sung to the tune of Rudolph the Red-Nosed Reindeer. University of Chicago professor Anil Kashyap unveiled this Friday at economists’ big annual conference.

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The Council of Economic Advisers just released an interesting paper examining the macroeconomic harm from the government shutdown and debt limit brinksmanship. To do so, they created a Weekly Economic Index from data that are released either daily or weekly (and weren’t delayed by the shutdown). These data include measures of consumer sentiment, unemployment claims, retail sales, steel production, and mortgage purchase applications.

The headline result: They estimate that the budget showdown cost about 120,000 jobs by October 12.

Looking ahead, I wonder whether this index might prove useful in identifying future shocks to the economy, whether positive or negative. As the authors note:

In normal times estimating weekly changes in the economy is likely to detract from the focus on the more meaningful longer term trends in the economy which are best measured over a monthly, quarterly, or even yearly basis. But when there is a sharp shift in the economic environment, analyzing high-frequency changes with only a very short lag since they occurred can be very valuable.

P.S. I am pleased to see CEA come down on the right side of the “brinksmanship” vs. “brinkmanship” debate.

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Ray Dalio, founder of the remarkably successful Bridgewater Associates, has released a 30 minute video explaining his vision of “How the Economic Machine Works.” Well worth watching, particularly his description of a beautiful deleveraging.

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