Tuesday, April 23, 2013

Checking my work

In ‘Keep it simple’, Marcus Nunes writes:

I may be missing something vital, but what bothered me about the R&R ‘fall-out’ was that the original study was concerned with public debt/GDP levels. The major finding of the critics was that, contrary to the original study, no ‘tipping-point’ (after which growth is negatively affected) was found.

My take: Debt results from deficits. Deficits follow government spending (given revenues). So why not go to the ‘source’, i.e., government spending, and check if it has a measurable impact on growth.

My kneejerk was to object to this simplification: "Debt results from deficits. Deficits follow government spending (given revenues)."

I'm not saying it's not true. It's simple arithmetic: If you spend more than your income, you have a deficit. If A is less than B, then A-B is less than zero. But it makes me cringe because there's no economics in it.

Marcus isn't the only one to look at deficits this way. People commonly look at deficits the way Marcus does in the excerpt. But it ignores all of the economic forces that may have come into play, forces that may have held back GDP growth, held back income growth, and held back tax revenue growth on the one hand. And on the other it ignores all the forces that may have worked themselves out by demanding the expansion of government spending.

No. Instead of that, we have B is greater than A.

And then I thought about my objection to Milton Friedman's MRTO graphs. Friedman compares "the quantity of money relative to output" to the price level, and finds great similarity.

My objection to Friedman's graph is that he forces the price level into the "money to output" ratio by removing the price level from the denominator of that ratio. The similarity that appears in the graph is due to circularity in the arithmetic. The similarity is manufactured by the calculation.

So Marcus relies on simple arithmetic to analyze deficits, and I object to that. On the other hand, Friedman ignores the simple arithmetic that invalidates his MRTO graph.

Friedman describes economic forces and I object based on simple arithmetic. Nunes uses simple arithmetic and I object based on economic forces.

I don't know what to make of this, but I want to think about it some.

Well that was easy.

Friedman relies on economic forces to show what he shows. But simple arithmetic shows the circularity that invalidates his work.

Nunes relies on simple arithmetic to show what he shows. But he ignores the economic forces that describe what is really going on.


jim said...

I'm mystified by the claim:
"Deficits follow government spending (given revenues)."

There is no resemblance to reality in that statement. If spending continued on the track it was on from 2001-2007, then it would be 100's of billions higher than it is now. And revenues are hardly a given - they're all over the place.


geerussell said...

Juxtaposing deficits with something I care about to look for meaning beyond simple arithmetic is a fun exercise. Unemployment seems like a great place to start.

The Arthurian said...

Yeowza! Thanks for the graph, G