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Monday, July 27, 2015 Serving Maine and Lincoln County for over a century. Volume 140 Issue 30

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10/23/2013 2:00:00 PM
The Coastal Economist
By Marcus Hutchins


The federal government is back up and running; for now. A new study, commissioned by Peter G. Peterson Foundation, and conducted by the St. Louis based Macroeconomic Advisers, LLC (MA), has attempted to quantify the economic cost of crisis-driven fiscal policy over the past few years.

This study quantifies damage in output and job loss. It also serves as a tool to understand some causal relationships in the macroeconomy.

From an economist's perspective, a sensible fiscal policy approach would include two main elements. The first and most critical need is a short term spending component to address current unemployment. A second requirement would be a long term deficit reduction component to address the CBO projections out to 2035 which indicate a growing budget imbalance caused by us baby-boomers.

Unfortunately we do not currently have a prudent fiscal policy. The Macroeconomic Advisors' paper points out four elements of what is called the "insensible policy process." These include first, the contraction in discretionary spending since 2010, second, the policy uncertainty since 2009, third, the recent government shutdown, and fourth, the debt ceiling fiascos in the midst of political fighting.

While the inefficiency of this fiscal approach is obvious, does it have actual costs, or is it merely noise for newspapers and pixels for weblogs? This is the very question raised by Macroeconomic Advisors' study. What did they do and what did they find?

Like most economic consultants, Macroeconomic Advisors has a large, computer-based model of the entire economy. This model was employed to simulate what would have happened under different scenarios and compared those results to what actually did happen in the economy since 2009.

The first element they reported concerns the federal spending squeeze. By way of background, for those who have the gift to forget, the budget impasses during the past two years created a stalemate resulting in a so-called sequester of spending cuts. These cuts were so random and economically perverse that no one seriously imagined that they would actually go into effect, but they actually went into effect.

What have the spending squeezes cost? By running a computer simulation of the economy without the spending cuts, Macroeconomic Advisors determined the squeeze reduced growth by 0.7 percent per year beginning in 2011. This pushed the unemployment rate up by an estimated 0.8 percent which equals a loss of 1.2 million jobs.

A number such as this fails to capture the impact of these upon real families and real individuals.

The second component of the "insensible process" comprises the fiscal uncertainty. The economists at Macroeconomic Advisors constructed an index along the lines of the Economic Policy Uncertainty Index, developed by Baker, Bloom and Davis. They modified the index to exclude certain cyclical elements, which have reverse causality with economic performance and exclude the component that deals with the Fed.

Their index focused on (a.) news mentions of economic policy uncertainty; (b.) the value of tax provisions expiring within two years; (c.) forecasters' disagreement about government spending one year ahead.

They observed three things. First, uncertainty seemed to have little direct influence on household behavior. This is good news. Apparently we do not, as a whole, take Congress too seriously.

Second, the stock market is significantly and adversely influenced by fiscal irresolution. This, in turn, lowers wealth. Third, credit spreads, i.e., the relative borrowing costs of companies versus the government rise with fiscal indecision. This third element means that fiscal waffling increases corporate borrowing costs.

These last two observations have exerted an indirect effect on the economy stemming from our fiscal dysfunction. How much is the damage? Macroeconomic Advisors calculated the cost at 0.3 percent of growth each year starting in 2010. This equals a rise of unemployment of 0.6 percent and a loss of 900,000 jobs.

Spending cuts and fiscal uncertainty together have truly altered the path of our economy and altered the lives of over two million of our US workers, but what about the recent shutdown? Has it really had any genuine impact? Several folks besides Macroeconomic Advisors have weighed in on this topic.

The consensus view according to my own survey of economists, as well as the Macroeconomic Advisors' study, indicate the loss of output has been at least 0.3 percent of fourth quarter GDP.

How does this translate into jobs? Macroeconomists use a law, which is really a rule of thumb known as "Okun's Law," named for economist Arthur Okun who first wrote about this in 1962. Using national income and employment data, Okun estimated that for every one percent annual rise in unemployment, our national income, i.e., GDP, declines by two percent, and vice versus.

So what does a 0.3 percent quarterly decrease in GDP do to employment and jobs? This rough rule of thumb would state that a 0.3 percent quarterly drop would be a 0.075 percent annual drop which would affect the unemployment rate by a negligible 0.038 percent.

At the current population and employment level, a one percent increase in unemployment is a loss of 1.5 million jobs. Using this relationship, the two week government shutdown, according to Okun's Law, cost our economy around 60,000 jobs. Nice going, boys.

Some readers might find this fiscal insensible policy process a bit perplexing. There are various ways to view this scene including political, social, etc. As an economist, I think that I speak for the mainstream of my profession with the following simple explanation.

The government, or public sector, as it is also known, creates goods and services for the economy. Large and small companies do the same. From time to time board members and directors of large corporations change. There is turnover at the top. These directors often move the corporation into new markets, and exit old markets. Throughout this process there is a common objective among the corporate board of directors to improve the product line and performance of the company.

This is traditionally how government has worked as well. In recent years there has been a discernible shift. We now have a number of congressmen, "corporate directors," who actually despise the "company" and nearly all of its products.

Such a group of directors, who disapprove of the company's existence as well as its product line, would wreak havoc at GE or GM. While the economics of public finance differ in significant ways from private sector finance, the corporate leadership principles have a fair degree of similarity. We cannot expect a smooth running government when a portion of its directors have an existential antipathy toward it.

Next week we will examine a bit more about these publicly produced products.

(Marcus Hutchins, MA, M. Phil, Economics, Columbia University, NYC, is a former economist, treasury bond arbitrage trader and hedge fund manager. He retired to Southport in 1997 where he resides with his wife Andrea and his youngest daughter Abbey. He welcomes feedback at coastaleconomist@me.com.)



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