I wonder how many readers have heard of N. Gregory Mankiw. He had a very distinguished career as a macro-economist in the 1980s and then in the 1990s was given a $1.4 million advance to write a textbook in Principles of Economics. This was almost three times the previous high advance and it made him a celebrity. That, plus his commitment to “Republican” principles of economics --- the negative effects of high marginal tax rates, the blame of persistent unemployment on the inability of prices to adjust completely – led to his being appointed head of George W. Bush’s Council of Economic Advisers in 2003. He is now back teaching at Harvard and writes a regular column for the NY Times Sunday Business section.
His most recent column published February 28 is entitled “The Biden Economy Risks a Speeding Ticket.” [Sunday Business Section, p. 10]. Before analyzing the column, I need to point out that the success of Mankiw’s textbooks is attributed to his ability to make economic principles clear using everyday analogies. This column follows in that pattern.
Mankiw’s column uses the metaphor of driving. The economic goals of the Biden COVID-19 relief bill, known as the American Rescue Act, are twofold: First and foremost, to provide relief in the form of income and assistance to small businesses to those tens of millions of Americans who are hurting badly due to the pandemic induced recession and to provide support for state and local governments to reopen schools and make sure the vaccines get into people’s arms as quickly as possible. Second, and equally important, to provide some stimulus to the economy to keep unemployment as low as possible, reduce the disappearance of even more small businesses and create economic momentum to sustain growth with minimal unemployment until the economy can get back on its own feet --- until things are “normal,” or as close to normal as possible given the lasting effects of the pandemic. Mankiw’s metaphor says that the highway goal is for the car (the economy) to get where it wants to go (full utilization of potential which usually translates into some minimal level of unemployment).
Mankiw: “You don’t know the speed limit. How hard do you push down on the accelerator?” (In economic terms, how much money should government pump into the economy?) Notice that he posits that the goal is to get to your destination (full utilization, minimal unemployment) but he doesn’t say that it is extremely important that you get there as fast as possible. We will return to this problem later in this analysis.
What is the economist’s version of the speed limit? And what is the economics penalty for exceeding the speed limit? If it’s a ticket you can afford, many people are willing to speed if they have to get somewhere quickly. Well, the economist’s version is the danger of what Mankiw calls “excessive inflation.” Once again, he doesn’t tell us what number for inflation is excessive. Two percent inflation in the personal consumption expenditure index is actually the Fed’s target rate. Is three or four percent “excessive” by Mankiw’s standards? This is important because at the end of the column, Mankiw is warning not about a “speeding ticket” but about a crash!
After digressing about whether the economic planners can learn things from the experiences of other countries or from our country’s previous experiences with government efforts to speed up the economy (which usually involves deficit spending by the government), he states that “… there are still limits to how fast the economy can go.” He describes the economy’s “speed limit” as the “…potential GDP …[which] measures the level of production of a maximally employed labor force. This occurs not when unemployment is zero but when it reaches a low sustainable level. When the economy’s production exceeds its potential, inflationary pressures start to build.”
What is the economy’s potential? Mankiw turns to the Congressional Budget Office, acknowledging that theirs is not a perfect measure but he assures us it is the best we have. In fact, research by economists at the Brookings Institution has revealed that the CBO projections of potential GDP have been off by a great deal in the past. But let’s let that issue go for now.
Mankiw: “According to the [CBO’s] numbers, GDP in the fourth quarter of 2020 was 3 percent below its potential. In dollar terms that gap amounts to $666 billion …” Mankiw notes that whatever extra spending is done by the federal government will have a ripple effect through the economy. A good estimate is that for every dollar the government spends, a dollar and a half of increased total production will occur. (For economics students, that means the “multiplier” is 1.5.). Thus, to get the full $666 Billion of increased output, the government need only spend $444 billion.
He then notes that there is already a lot of spending in the pipeline from the $900 billion approved by Congress towards the end of last year and concludes “… fiscal policymakers may have already pushed on the accelerator hard enough to bring the economy close to the speed limit by [this] year’s end … Another $1.9 trillion … could push the economy well beyond the limit.”
Mankiw then acknowledges that the economy produced “above potential” in 2019 and there wasn’t a whiff of inflation. He has an answer, “In 2019 GDP exceeded its estimated potential by less than 1 percent, so inflationary pressures, if any, were weak. By contrast when President Lyndon Johnson’s “guns and butter” policy stoked inflation in the mid-1960s, output exceeded potential by 5 percent. Mr. Biden’s proposed stimulus could bring us back to that range.”
Here is where the discussion leaves the realm of economic analysis and becomes politicized gaslighting. There are a lot of uncertainties behind the word “could” in the last sentence. There is a lot of unspoken historical assertions in the above quoted passage and what follows.
Mankiw: “When inflation got out of hand starting in the 1960s, it took until Jimmy Carter’s appointment of Paul Volcker as Fed chairman in 1979 to get things back under control. The cost of the disinflation was a recession in 1982 …. Put differently, speeding is dangerous. The result can be not just a ticket but a crash.”
Whew! Please note what Mankiw has done. He blamed over a decade of inflation between 1966 and 1981 on the deficits run between 1965 and 1968. First of all, the deficits from 1965-1968 caused the rate of inflation to rise slowly for five years maxing out at around 5 percent in 1970. A recession in 1970 reduced the rate of inflation. Beginning in 1973, there was a major oil price shock that raised inflation way above what it had been in the late 1960s. The federal deficit as a percentage of GDP maxed out at 5 percent in 1976 and began to fall through 1979 when another oil price shock associated with the Iranian Revolution pushed inflation even higher. It was the very high inflation at the end of the 1970s, NOT the Lyndon Johnson “overspending” of the 1960s that caused the Volcker Fed to clamp down hard on the economy in 1981 --- causing that very deep recession.
[For a quarterly graph of the ratio of the federal budget deficit to GDP, see the Federal Reserve Bank of St. Louis’ data available at https://fred.stlouisfed.org/series/FYFSGDA188S. For the rate of inflation from the St. Louis Fed’s data see https://fred.stlouisfed.org/series/FPCPITOTLZGUSA]
Mankiw’s use of numbers from the CBO (numbers fraught with uncertainty that he sweeps under the rug) coupled with his misrepresentation of the history of the 1960s and 70s is gaslighting plain and simple. This highlights the fact that he is a highly politicized economist who can always figure out a way to dress up whatever policies he’s supporting in fancy sounding analogies replete with numbers.
Let’s get back to Biden’s COVID relief package and the so-called “danger” of inflation. In calendar year 2020, inflation was well below the Fed’s 2 percent target for price increases for personal consumption items. Since that rate has averaged below 2 percent for many years, the Fed in on record as believing some years of above 2 percent inflation are called for.
Meanwhile, the Fed’s understanding of how to calculate “maximum sustainable employment” (the unemployment rate below which inflation starts to accelerate) has undergone a change. It used to be that the target was five percent unemployment. Recently, though, the Fed has changed their goal to an indeterminate level. In other words, to use Mankiw’s analogy, the Fed no longer is advertising a fixed speed limit. They will not automatically slow the economy if unemployment goes below, say five percent. This is understandable because unemployment has been below 5% from 2016 through March of last year. (It was 3.5% then.) Contrary to Mankiw’s worries about inflation accelerating, there was no indication of that during those years of quite low unemployment. Today, the unemployment rate is 6.5%. In addition, job growth has recently stalled because all the benefits of the CARES act from last spring ran out during the summer. This suggests that a big stomp on the accelerator is needed.
[For a graph of total nonfarm employment showing the dramatic drop in March of last year and the half-way recovery that stalled in the summer see the following data from the Bureau fo Labor Statistics: https://www.bls.gov/ces/publications/highlights/2021/current-employment-statistics-highlights-01-2021.pdf]
Actually, aside from Mankiw’s misuse of history, the most significant thing about his column is what he omitted. His fear mongering about the danger of inflation never once acknowledges what the vast majority of economists, from Janet Yellen, Secretary of Treasury, to Jerome Powell Chairman of the Fed, to the Chamber of Commerce, to Mark Zandi of Moody Analytics are saying.
[For Zandi’s analysis for Moody Analytics see Mark Zandi and Bernard Yaros, “The Biden Fiscal Rescue Package: Light on the Horizon” available at https://www.moodysanalytics.com/-/media/article/2021/economic-assessment-of-biden-fiscal-rescue-package.pdf.]
They all agree that the cost of doing too little (slowing down on the highway and therefore putting off the day when the economy will have come “all the way back”) is so much more than the cost of doing too much (if inflation were to get all the way up to, say, three or four percent!). This is where his failure at the beginning of the article to highlight the absolute necessity of bringing the economy back as quickly as possible is important. In 2009, the Recovery Act pushed through by the Obama Administration was woefully inadequate to the task. Instead of a rapid recovery from the Great Recession of 2007-2009, it took over six years (till 2015) for the unemployment rate to fall back to five percent. It is this sluggish recovery from the last recession that is informing not just the Biden Administration policy makers like Janet Yellen, but the economists from the Chamber, Powell of the Fed and Zandi of Moody Analytics.
Mankiw’s failure to even acknowledge the argument about the dangers of doing too little, let alone give a decent response to it is a sure sign that his piece is political gas lighting rather than real economic analysis.
[For more details on this issue, see Emily Stewart, “The risks of going too big on stimulus are real — but going too small could be riskier. The debate over how big to go on the economic recovery, explained,” available at https://www.vox.com/policy-and-politics/22268787/larry-summers-op-ed-biden-stimulus]
Michael Meeropol is professor emeritus of Economics at Western New England University. He is the author with Howard and Paul Sherman of the recently published second edition of Principles of Macroeconomics: Activist vs. Austerity Policies
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