The Danger of Misleading Economic Arguments

     A recent post over at Mike Kimel demonstrates the danger of this yet again. Which is why I like economics so much-if you understand it you are much less likely to be snookered by bad arguments. However a new example of this happened last night.

    It was with regard to an interesting post Kimel-as Nanute pointed out to me its Kimel, not Simel-wrote regarding the level of correlation between nonmilitary government spending and the U.S. recovery during the Great Depression.
 
    http://www.angrybearblog.com/2011/11/how-keynesian-policy-led-economic.html#more

    He wrote this in response to a debate he had got into with Scott Sumner over the relative importance-or lack thereof-of fiscal as opposed to monetary policy in the recovery. Sumner had basically argued that monetary policy, especially FDR getting us off the gold standard which led the devaluation of the U.S. currency, was the main stimulant and argued that fiscal stimulus had little or nothing to do with it.

    http://diaryofarepublicanhater.blogspot.com/2011/11/very-latest-on-sumner-kimel.html


    Kimel's argument is that due to the strong correlation of nonmilitary government spending growth and GDP growth during the period-if you like charts Kimel provides you with some(I'm not that big a chart guy myself, different strokes). He ultimately concludes that there was a 90 percent correlation between the recovery and nonmilitary government spending-ie, fiscal stimulus. This leaves only 10 percent at most to be accounted for by monetary stimulus.

    In this Kimel is more or less 180 degrees from Sumner who argues the reverse effectively. I have argued that Eggertsson seems to me the most plausible-he ascribes a large part to play for each.

    "What ended the Great Depression in the United States? What ended the Great Depression in the United States? This paper suggests that the recovery was driven by a shift in expectations.This shift was triggered by President Franklin Delano Roosevelt’s (FDR) policy actions. On the monetary policy side, Roosevelt abolished the gold standard and announced an explicit policy objective of inflating the price level to pre-Depression levels. On the fiscal policy side, Roosevelt expanded real and deficit spending which helped make his policy objective credible. The key to the recovery was the successful management of expectations about future policy."

    http://www.ny.frb.org/research/economists/eggertsson/Great_Exp_AER.pdf

    He estimates that New Deal-fiscally stimulative-policies where 55% responsible for the recovery in output between 1933-37 and 70% responsible for the recovery in inflation during the same period.

     http://www.ny.frb.org/research/economists/eggertsson/WastheNewDealContractionary.pdf

     I pointed this out in a comment to Kimel:

     "Very interesting work! I think you are right about the importance of nonmilitary government spending though I do think monetary policy had a little higher proportion than you think  You say fiscal stimulus had 90 percent to do with it, Sumner says monetary policy had 90 percent to do with it, I think Eggertsson was closest to right."

     "Your argument is a correlative argument-as is his. He argues that improvement in both prices and industrial production correlates time wise with FDR getting us off the gold standard. You argue for the correlation percentage wise between nongovernment spending and GDP growth. Both correlations are highly suggestive but not proof beyond a shadow of a doubt."

     Kimel responded this way:

      "Bear in mind one difference between what Sumner is doing and what I am doing.  I am claiming an extremely correlation between spending decisions made one and two years earlier and economic growth.  Correlation does not imply causality, of course, but if two things correlate highly and one leads the other by a weighted average of one and two years, it is suggestive.  There is no way to prove causality, of course."

     I admitted to him that I didn't entirely understand the importance of this distinction so he elaborated.

     "Monetary policy is set based on current economic conditions, or expectations of those conditions.  And those setting monetary policy tend to have pretty good information.  What leads and what follows is very tricky if events are only a month or two apart.  Yes, the money supply might increase just before the economy picks up, but did the money supply improve the economy, or did the Fed act pre-emptively to ensure that there was adequate money in the system to avoid smothering the incipient recovery their privileged position allowed them to see."

     So the time factor can be very significant in analyzing causality. It is a subtle distinction which can make all the difference. This is why I like economics as I said above: so I am much less likely to be snookered by clever but misleading arguments.

     There was another discussion in the comments section which I admit totally drank the koolaid on. Mike Gordon-aka the Buggy Professor-left a very long comment which argued that in reality Hoover spent as much or more as FDR did and that the New Deal was largely a continuation of Hoover policies. The significance of this is that if we had very high nonmilitary government spending in the 1929-33 period then this would throw into question anew the issue of correlation-if high government spending correlates with two periods one of great economic contraction-1929-1933-and one of strong economic recovery-1933-37-it kind of leaves us back at the drawing board. It might seem a wash.

    "In concrete terms --- surprise! surprise! --- the Hoover administration increased federal spending between March 1929 and March 1933 by 88% in per capita income terms.  By contrast, the first 7 years of the FDR administrations entailed an increase of only 74% in such spending (all measured in 1990 constant dollars for the period between 1929 and 1940)."

    "These figures are all the more startling if you view them from another angle.  In seven years, FDR’s deficit spending measured in per capita income averaged 11% increases.  The average in the Hoover four-years rose twice as fast."

   Mike Gordon listed these sources: 

   "Sources, with tables and figures for all the relevant data, go tohttp://www.cato.org/pubs/journal/cj16n2-2. html .  See also:  http://www.whitehouse.gov/sites/default/files/omb/budget/fy2009/pdf/hist.pdf   For an easy-to-follow source, with a good table, go here: http://dailyreckoning.com/krugmans-hoover-history/  The quote taken from Jonathan Alter’s book is fromhttp://en.wikipedia.org/wiki/Herbert_Hoover "

   I was quite taken by all this. I didn't really know what to make of it but I wrote to Gordon and said:

   "Mike the buggy professor, thanks for that it is really interesting and thought provoking information. Yet you argue that the argument can be salvaged? How is that again? If you could elaborate on, "The discretionary deficit spending was better targeted in the FDR era, including all the infrastructure investments." it might help."

    "What all this might show is that Hoover gets a much worse rap than deserved."

     However this morning Nanute pointed out to me that Jazzhumpa had countered Gordon pretty decisively:

     "I don't know if you followed the comment thread in Kimel's latest post to the end. Jazzbumpa shows some very good data that would lead one to conclude that the argument made by Cato is pure bullshit. He has a very good blog too."
     Here is Jazzbumpa:

      "I've only skimmed your posts.  You sent me off in search of data.  Any time anyone cites Cato as a source my skepticism goes into overdrive."

       Now I of course noticed Gordon had a lot of his source from Cato but figured you can't simply refute because of a source, though it should make you wary.

       "From table 1.1 at http://www.gpoaccess.gov/usbudget/fy10/hist.html we get revenues/outlays and surplus or deficit for every year back to 1901."

      "Outlays for CT 1929 were $3127 million, for CY 1933 they were $4598 million, an increase of 47.04% in 4 years.  I probably should have used 1930 instead of 29.  But the numbers for those two years are ball park similar."

       He then provides these numbers:

       Yr      Rcpts    Outlays    S or D
1926    3,795    2,930    865
1927    4,013    2,857    1,155
1928    3,900    2,961    939
1929    3,862    3,127    734
1930    4,058    3,320    738
1931    3,116    3,577    -462
1932    1,924    4,659    -2,735
1933    1,997    4,598    -2,602
1934    2,955    6,541    -3,586
1935    3,609    6,412    -2,803
1936    3,923    8,228    -4,304
1937    5,387    7,580    -2,193
1938    6,751    6,840    -89
1939    6,295    9,141    -2,846
1940    6,548    9,468    -2,920
1941    8,712    13,653    -4,941
1942    14,634    35,137    -20,503

     Looking at these numbers we get a very different sense, we see that while spending did increase under Hoover, not nearly as much as under FDR. The use of "per capita" stats is used very widely by folks like Cato the better to mislead. Like right now I could point out that there is no demand problem as don't you know that per capita consumption is up right now?

     This is the beauty of economics. The better we understand, the less we are mislead.