On February 17, Christina Romer and three other former Council of Economic Advisers (CEA) chairs joined in a letter in panning economist Gerald Friedman's analysis of Bernie Sanders' economic plan. In the letter and elsewhere, in hyperbolic language they ridiculed his findings and by implication Sanders' economics. Where Friedman found substantial positive impacts from the substantial initiatives in the plan, the four former chief economists to the president found fairy tales and flying puppies.
In less than twenty-four hours there was pushback, from James K. Galbraith, among others. Galbraith's letter criticized the CEA chairs for using high position rather than reasoned examination, and excoriating their lesser-known colleague without foundation. Indeed, detail was conspicuously absent. Galbraith described the model used by Friedman, saying it was not out of line with what the CBO and CEA themselves employ and the results were consistent with historical precedent. Thus challenged, a few days later one of the four, Romer and her economist husband David Romer provided detail.
Conceptual Frameworks: Static vs. Dynamic
We had a chance to review the Friedman report, the Romers' paper, and Friedman's rebuttal. It turns out the devil is not so much in the details as in the conceptual framework. We found that the Romers' basic critique is weak, and Friedman is correct in saying it is based on a brittle understanding of how the economy works.
Friedman's model imagines a dynamic economy, the Romers a very static economy. The view that government investment and spending can expand the economy is explicit in Friedman's view. The Romers suggest that things may get better while the spending is going on, but will contract to the previous state, or even below, once it's over, kind of like taking a big breath, where you look bigger for a moment, but when you exhale you revert to the 98-pound weakling, worse off for the exercise.
The Romers appeal to a higher law, a "standard economics" as if it were a universally accepted and validated norm that Friedman does not understand. They define error as deviation from this standard economics. Their inability to admit, or perhaps even recognize, that this is a conceptual difference is troubling. While it may be that the static equilibrium view they hold is the flavor of the moment in Academia, it is far from being universally accepted, nor has it always been the norm. Friedman points out in his rebuttal that his is closer to the economics of Keynes. (The "standard economics' of the moment comes under the title "New Keynesian", but much like the program of Neoliberalism is not liberal as most use the term, nor are Neoclassical economists very close to Classicals, New Keynesians owe more to John Hicks and Paul Samuelson and earlier 20th century economists than they do to John Maynard Keynes.)
A term more appropriate than "standard" would be "Establishment" economics, and more narrowly, the establishment of the past thirty or thirty-five years. To illustrate how things have changed, one is reminded of Michal Kalecki, a major economist in the middle of the 20th century. (The Keynes' model was once referred to as the Keynes-Kalecki model.) Kalecki once characterized another "standard" economics when he once observed [from "Political Aspects of Full Employment"]:
"A solid majority of economists is now of the opinion that, even in a capitalist system, full employment may be secured by a government spending programme ... If the government undertakes public investment (e.g., builds schools, hospitals and highways) or subsidizes mass consumption (by family allowances, reduction of indirect taxation, or subsidies to keep down the prices of necessities), and if this expenditure is financed by borrowing and not by taxation ... the effective demand for goods and services may be increased up to a point where full employment is achieved.)"
A Failed Establishment
Another, more appropriate term for the Romers' "standard" economics would be "failed," since economists of this school universally failed to see the Great Financial Crisis coming, to understand it when it happened, and to effectively mitigate many of its impacts. It failed Christina Romer herself, as we noted in our previous piece, when as CEA chair during the Obama stimulus period she predicted an immediate turnaround in employment, as the stimulus accelerated the natural return to equilibrium.
When the effects failed to materialize as she predicted, the policy of government spending as a corrective was discredited, at least in political circles, and so it remains to this day.
One might have expected a more charitable tone from her toward Gerald Friedman' rather than doubling down on her past failure.
It is also worth noting that even central bankers are by not averse to the kind of fiscal measures embodied in the Sanders plan, and are in fact wringing their hands for the absence of such.
The Inflation Expectation Bogey Man and Interest Rates
The most telling point in the Romers' weak, if strident, paper is that interest rates are sure to rise and this may very well prevent the kind of outcomes Friedman projects. Of course, monetary policy needs to accommodate the expansion, and the Federal Reserve - itself in the grip of another major fallacy of standard economics - is almost sure to squelch recovery, once it begins, for fear of inflation.
The Romers say "interest rates will rise". But in fact, as they admit elsewhere, rates will rise not for any natural or market-driven reason, but because the Fed will raise them. Is this a shortcoming of Friedman's analysis? It is not. He makes the explicit assumption of accommodative monetary policy, and for his purposes it would not be proper to assume otherwise, or to try to anticipate when and how the Fed will act.
Informing, if that is the word, the Fed's raising rates is the doctrine of NAIRU. NAIRU, the Non-Accelerating Inflation Rate of Unemployment, is a fallacy that contends that at some indistinct and moving rate of unemployment the inflation genie will get out of the bottle and run amok. NAIRU survived both the stagflation of the 1970s and the high employment/low inflation of the 1990s as well as the era previous to 1963, and became a favorite of Alan Greenspan. It is highly likely the Fed will act from its belief in NAIRU following the belief it is preventing a runaway inflation.
Inflationary Pressures and Productivity
Some temporary inflation would naturally accompany implementation of the Sanders plan, since rather than being stuck in financial markets like the QE's and zero interest rates, money would be flowing into the real economy. Most components of the plan would generate increased demand for consumer goods.
The great likelihood is that - as in the past - production will expand, imports will increase, and productivity will adjust to counteract inflation.
The opposite is implicit in NAIRU, which predicts an acceleration of inflation. So the Fed will likely abort any expansion by raising interest rates and inciting a slowdown, and history shows that the Fed does much better in crushing expansions by raising rates than it does in instigating recoveries by reducing them.
The ineffectiveness of unprecedented zero percent for the past six years is evidence enough at one end.
At the other, we remember the Greenspan and Bernanke hikes in Fed rates prior to the last two recessions. But in common with other tenets of standard economics that have not proven out, NAIRU survives as a major driver of policy.
Money and Debt
We find Friedman's analysis completely coherent and without major flaws, as far as it goes. Had we done the analysis we would have added an examination of money and debt, which are absent in the orthodox standard economics (as odd as that may seem to the layman), aside from the investment multiplier itself, which is basically a monetary phenomenon.
We see the injection of debt-free (to the private sector) money into the real economy as income to workers and the mitigation of the student debt time bomb as significantly therapeutic. As we noted last time, multipliers are lower today than they have been in the past, and this is likely due to the paying down of debt rather than spending on into the economy. But even as debt reduces the multiplier, insofar as it is paid down, the economy becomes more stable.
Even inflation is not without its benefits. As Hyman Minsky pointed out. Inflation reduces the real burden of debt. An excellent example is the deep double-dip recession at the beginning of the 1980s. Absent the mitigation of inflation - however messy - that recovery could not have taken place.
Alas, The Romers are Found Wanting
So, to conclude, there are problems with the Romers' conceptual framework as well as their stridently dismissive tone. There are also mistakes in the detail of their paper, problems to which we may return. Suffice it to say, our judgement is quite contrary to theirs. A full accounting of the debate is available from Dave Johnson at "The Sanders Economic Plan Controversy".