Sunday, November 25, 2012

Simulacron: The Keynes-Reagan Shift

From John Boehner's

“The reason it [the economy] isn’t doing better is quite simple – excessive government spending."

The Freeman: What Spending and Deficits Do by Henry Hazlitt:

The greater the amount of government spending, the more it depresses the economy. Government spending:

...volumes of research have shown that excessive government spending that causes chronic budget deficits is one of the most serious drags on economic dynamism.

The standard argument against government spending is that it hinders economic growth. It drags on economic dynamism. It depresses the economy. It is the reason the economy isn’t doing better. It certainly gets repeated a lot.

William A. Niskanen, Reaganomics:

"Only by reducing the growth of government," said Ronald Reagan, "can we increase the growth of the economy."

And how do we measure government spending?

PolitiFact Virginia: Mark Warner, 17 April 2011:

"Right now we are spending at an all-time high, close to 25 percent of our GDP [is] being spent on the federal government. But our revenues are at an almost all-time low of about 15 percent [of GDP]."

Center on Budget and Policy Priorities: Federal Spending Target of 21 Percent of GDP Not Appropriate Benchmark for Deficit-Reduction Efforts:

Over the 40 years from 1970 through 2009, revenues averaged a little over 18 percent of GDP, and expenditures averaged nearly 21 percent of GDP.

Paul Krugman: The Truth About Federal Spending:

The fact is that federal spending rose from 19.6% of GDP in fiscal 2007 to 23.8% of GDP in fiscal 2010.

The yardstick for government spending is GDP.

The yardstick for government spending is GDP. But GDP is the thing that is not growing. The yardstick is shrinking. And this is what we use to measure Federal spending.

The shrinking yardstick creates the appearance of excessive Federal spending growth. But what is the truth? Is Federal spending growing excessively? Or does it only seem that way because the yardstick is shrinking?

Has anyone ever addressed this question? To my knowledge, no.

The argument for cutting government spending is that the spending hinders economic growth. And we know that GDP growth is slow. But slow GDP growth is not evidence that government spending is the cause of slow GDP growth.

What is the evidence?

We know that GDP is not growing fast enough. They say government spending is to blame. And their proof is that government spending is growing relative to GDP. The proof is that government spending is growing faster than the thing that is not growing fast enough.

I went back and forth for two days, trying to determine where to show the trend-change in my "trend of real GDP" numbers. Finally I decided to go with 1980.

Growth is exponential. Real (inflation-adjusted) GDP, shown in red on Graph #1, closely follows the exponential trend line shown in black:

Graph #1: Real GDP (Quarterly) 1947-2007 and Exponential Trend

But take a closer look. For the first half, the left half of the graph, the red line is on the black line or above it. In the second half, the red line is on the black line or below it.

In the first half of the graph, the red line starts out slightly below the trend line but gains on it. In the second half, the red line ever so gradually falls below the trend. And I should point out, this graph stops in 2007. The graph stops before the financial crisis of 2008 and the recession of 2009 and the large fall of RGDP below trend that occurred at that time. This graph doesn't show that.

In the first half, the graph shows, economic performance was better than trend. In the second half economic performance was worse than trend. I therefore decided to split the data into two halves, and calculate the trend of each half separately.

I plotted the early years and late years as separate lines, then had Excel put exponential trend lines on them. Then I used the exponential formulas Excel came up with, and calculated the trend values as numbers so I could work with the numbers. Graph #2 shows black trend lines based on the numbers I calculated from those formulas.

Graph #2: Early Period (red) and Late Period (blue) with Calculated Trends
The X-Axis numbers here are "count of quarters" (quarterly data)
Notice that the early years RGDP (red) hugs its trend line more closely than on Graph #1. So does the late years RGDP. What happened is, the two trend lines here are a little different than the one trend line on Graph #1.

I took out the RGDP data so I could look at the trend lines. I scaled the two trend lines so they start at the value 100, and I showed them both for both halves of the graph. After 60 years or so, the late years trend (red) increases from 100 to about 700. The early years trend (blue) increases from 100 to 950 or so, nearly 1000.

Graph #3: Two Different Trend Lines

Now we're getting there. I re-scaled the late (red) trend and showed it starting at 1980, when the trend actually slowed. The faster-rising early (blue) trend I showed both early (as it occurred) and late (for comparison to the red trend line).

Graph #4:The Late Trend of RGDP Growth (red) Shown as it Occurred.
The Early Trend (blue) Shown Early and Late for Comparison.
As before, the blue trend reaches near 1000 by the end. The red line reaches higher than before, above 800 now instead of only 700, because the red line got a free ride on the blue line for 30 years.

Also, the separation of the red and blue lines is smaller on Graph #4 than #3 because #4 shows 30 years of late trend instead of 60.

What I have developed here is a growth index. It is similar to a price index that economists might use to convert between "real" and "nominal" values. But this index can be used to convert "late period" RGDP values to values fitted to the "early period" trend. I'll be doing that tomorrow. Here's a peek:

Graph #5: RGDP values (red) fitted to the Early Period Trend (blue)

Graph #5 shows the slower pace of real GDP growth that has been a focus of concern since the time of Reagan or before. It will be interesting to work with these higher values that are based on pre-1980 growth. They will make a larger denominator when we look at "Federal spending relative to GDP" and when we look at "Federal tax dollars relative to GDP" and when we look at "Federal debt relative to GDP'.

And that's just for starters.

The Excel file containing these graphs and the numbers behind them is available to view and download.


jim said...

From John Boehner's

“The reason it [the economy] isn’t doing better is quite simple – excessive government spending."

If Boehner really believed that then Congress would not have raised the debt limit in Aug 2011. He knows that would have caused an almost immediate recession leading to a depression if Congress persisted and did not relent.

It would have been easy to test his theory, but he already knows the outcome.

The Arthurian said...

Yet the "fiscal cliff" remains an issue.

jim said...

If Congress does nothing before Jan 1 and the spending cuts and tax increases become effective, there will be (according to IMF) a 4% decrease in GDP. The spending cuts that begin Jan. 2 are only something like 1% of GDP so the net result is federal spending to GDP ratio will increase