What’s Our Economic Problem? Rational Expectations About Bad Policy

Or at least that’s what Robert Lucas says in a September 24 interview in the WSJ.

Mr. Lucas believes Ben Bernanke acted properly to prop up the system. He doesn’t even find fault with Mr. Obama’s first stimulus plan. “If you think Bernanke did a great job tossing out a trillion dollars, why is it a bad idea for the executive to toss out a trillion dollars? It’s not an inappropriate thing in a recession to push money out there and trying to keep spending from falling too much, and we did that.”

But that was then. In the U.S. at least, the liquidity problems that manifested themselves in 2008 have long since been addressed. To repeat the exercise now with temporary tax and spending gimmicks is to produce the opposite of the desired effect in consumers and business owners, who by now are back to taking a longer view. Says Mr. Lucas: “The president keeps focusing on transitory things. He grudgingly says, ‘OK, we’ll keep the Bush tax cuts on for a couple years.’ That’s just the wrong thing to say. What I care about is what’s the tax rate going to be when my project begins to bear fruit?

About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
This entry was posted in Economical Musings. Bookmark the permalink.

22 Responses to What’s Our Economic Problem? Rational Expectations About Bad Policy

  1. D. C. Sessions says:

    You’ve just explained why businesses are deferring long-term capital expenditures on software and equipment in favor of more labor-intensive but less capital-intensive current methods of providing goods and services. After all, once you buy the equipment you’ve spent the money but labor can be cut loose at minimal cost.

  2. Dr X says:


    I don’t closely follow the numbers in these matters, but your comment made me think immediately to something Brad DeLong wrote back in July, which reminds me of something else I should add to that long stimulus thread.


    Relative to the cash being held by businesses, they aren’t investing nearly as much as they could if they expected an increase in demand, but the real decline investment is in the construction industry, at least according to DeLong. No?

  3. James Hanley says:

    Actually, in accord with what Dr. X wrote, there seems to be much stronger increases in purchases of capital equipment than in labor, which is why this has been such a jobless recovery (to the limited extent that it’s properly considered a recovery). The reasoning I’m hearing is that the capital investment seems a better bet to them because of the high costs of labor, especially including on-going increases in health care cots, and they’re uncertainty about future tax rates.

  4. James Hanley says:

    Addendum: I think, at least superficially, that part of the problem is the on-going uncertainty about the political future. Nobody has relative certainty what the tax rates and regulations are going to be two years from now, because the divide in D.C. is so vast that we can no longer expect the middle ground to keep things going pretty much as is, with just marginal changes. Instead of just “muddling through” with incremental change (c.f., Charles Lindblom), we face the possibility of radical change, or at least a sharp and repeated see-sawing of policy. What would I bet on in such an uncertain climate? U.S. bonds. Although there’s s continuing threat of sovereign default, that can be expected to be a temporary and soon rectified situation, leaving them still as by far the most secure investment in insecure times.

  5. Dr X says:

    @ James:

    The reasoning I’m hearing is that the capital investment seems a better bet to them because of the high costs of labor, especially including on-going increases in health care cots, and they’re uncertainty about future tax rates.

    I’ve heard that, and I’ve also heard that when sitting on so much cash that is earning so little, the savings from equipment and software upgrades (that can also be written off 100% in the year of purchase) is a pretty safe bet for profitable businesses that have plenty of cash. Upgrade now, while money is cheap, and get big tax breaks in year one, as well as savings that play out over the longer term.

    This complements what your saying because these factors only make investment in software and equipment that much more preferable to hiring more people. Throw on top of that the possibility that these upgrades might themselves reduce the amount of labor needed to maintain current levels of production.

  6. D. C. Sessions says:

    I’m missing something. Y’all are writing as though hiring an employee is a multi-year commitment with major exit costs. I know that’s the case in Europe, but hadn’t heard that it applied in the USA.

    Did I miss the news?

  7. Dr X says:

    Hiring an employee is quite often very costly up front, with returns coming later. First, there are recruitment costs which can run very high. Depending upon the job, I know that some companies regard experienced middle and upper management as a loss in the first year because of recruitment costs and because it can take that long to get up and running effectively in a more complex management position. So a company may believe that it is making a multi-year commitment when they decide to hire such a person. All those management and MBA-skill positions that can’t be satisfactorily filled by Deloitte temps are very costly up front, not to mention the temps are pricey, but not as pricey as committing to a full-time permanent hire. That’s why companies go with temps where possible.

    The same could apply to any job requiring a lot of upfront learning.

  8. Troublesome Frog says:

    You’ve hit on one of my hot button issues here. I see the “regulatory uncertainty” idea as one of the biggest piles of steaming horse pucky in economic discourse. Aside from the fact that it’s transparently an attempt to blame economic problems on a certain usurper scaring the economy (and implying that the economy would be far less frightened if only we hadn’t elected a crazy leftist who Might Do Anything), it just doesn’t seem to have any data to support it.

    To the extent that it’s testable (and not just an accusation of Obama putting “the whammy” on the economy), the tests seem to fail. As others have pointed out, nobody seems to have any trouble spending money on capital investment. Hiring a worker is at least as easy to back out of as a large captial purchase. Dr X makes the point that skilled workers and middle managers are often expensive up front. This is true, but our most serious unemployment problem is with less skilled workers who should be easy to hire and fire. Educated employees are much better off right now.

    Larry Mishel has a pretty good summary of the objections to this line of argument. What I would like to see from the people pushing this idea is some meaningful piece of evidence that it’s true. I’ll go with a thought experiment without any data if the thought experiment seems intuitively sensible, but when I first heard it, I cataloged it along with nonesense like, “The Depression was caused by fear of Roosevelt’s socialist agenda traveling back in time to frighten business.” This one seems to have legs in the absence of both data and intuitive appeal.

  9. Dr X says:

    Troublsesome Frog.

    I think you’re correct about how the uncertainty argument is used in typical politically-motivated conversation, and I find that annoying, as well. The weak president doesn’t inspire confidence in the future; he hasn’t charted a definite course, so no one knows what to do. They don’t know where taxes will be, blah, blah, blah. IMO, that’s not what’s happening, but it’s an argument that feels good if you’re a conservative and, of course, you don’t like Obama.

    I don’t think I mentioned uncertainty in any of my comments, but I think it’s relevant to the discussion, but not for the reasons often stated for political purposes. I think businesses are uncertain about future demand. Very simply, as DC has written, there’s been a consumer credit contraction; people who were over-leveraged have variously decreased borrowing, gone bankrupt, they’re paying down debt and they’re being more cautious with money. Demand falls and unemployment rises. Businesses have money available to invest, but what do they invest in? Increasing production would increase costs and inventory levels if spending doesn’t increase. So if we want to use the word uncertainty meaningfully, it would be uncertainty about increasing output without price signals indicating what to increase output of and how much to increase it.

    As I’ve probably made fairly clear in other threads, I lean toward the liquidity trap explanation for our situation, rather than a personality-caused jobless recovery. I think actual price signals are far more important than assessments of the president’s attitudes.

  10. James Hanley says:

    What I would like to see from the people pushing this idea is some meaningful piece of evidence that it’s true.

    Sure, I’d like to see that from any macroeconomist, in support of any of their theories.

  11. Troublesome Frog says:

    James Hanley:

    Sure, I’d like to see that from any macroeconomist, in support of any of their theories.

    Well, there’s hand waving and then there’s hand waving. This is definitely the latter. Over the past couple of years, I think that we’ve seen a few cases of economists stepping up with predictions that are fairly objective. The inflation vs deflation and low interest rate vs high interest rate camps definitely staked out real positions in 2009. The results seem pretty clear so far. I doubt that it will change many minds, but David Frum paraphrases Susan Sontag pretty well on this:

    Imagine, if you will, someone who read only the Wall Street Journal editorial page between 2000 and 2011, and someone in the same period who read only the collected columns of Paul Krugman. Which reader would have been better informed about the realities of the current economic crisis? The answer, I think, should give us pause. Can it be that our enemies were right?

    I don’t need a massive overarching theory and piles of statistical data. I’m just looking for a first order analysis like, “If this is true, I would expect to see X.” The X I’m thinking of is things like, “Surveys that say that regulatory uncertainty is unusually problematic,” or, “Businesses not making large capital investments,” or, “Slow growth in sectors that are most subject to regulation (energy, medicine, etc).” These things are pretty easily checked, and none of them seems to support Dr. Lucas.

  12. James Hanley says:


    I get your concerns. But it’s not ridiculous to think that there are times when businesses hunker down and wait to see how the politics plays out.

    As for Frum’s argument, I’ve previously critiqued this comparing of the WSJ’s editorial page with Krugman. The WSJ editorial page isn’t written by economists, so the comparison is inapt–it’s a rigged game (especially since we all know how silly the WSJ editorials are). Not that I ever read the NYT, but I suspect a comparison of its’ editorials with the arguments of any leading economist might not shine so favorably on them,either.

  13. Troublesome Frog says:

    James Hanley

    I get your concerns. But it’s not ridiculous to think that there are times when businesses hunker down and wait to see how the politics plays out.

    I’m being a little hard on Lucas in this case, because he does say that this is a gut feeling rather than something he bases on evidence. I think it’s a little sad that this is where he goes with his reasoning, but I respect him for admitting it. Others are not quite so coy.

    I would say that in the absence of other compelling first order problems, that would be an excellent hypothesis. Even with other first order problems, it’s at least a hypothesis that one could look at. But it’s a hypothesis. One that can be tested. And one that appears to fail the sensible tests I can think of. So why is this a major issue in the face of other possibilities? Stories like, “They won’t hire that guy in the mailroom because they fear the Employer Mandate kicking in when 2014 rolls around,” just don’t seem like first order concerns with everything else floating around. At some point it sounds like an excuse for things not working out as predicted rather than a meaningful conclusion drawn from data.

    I have never owned a business, but I have some notions of how they behave. When I ask myself how a business would respond, my real thought process is, “Given the current environment, would this be an important consideration for me in their position, or one that sits in the noise in this model?” Regulations (whose nature is unclear) years away on employees I could dump in a heartbeat, or minor fluctuations in taxes on my profits would pale in comparison to my fear of not having customers or having somebody who owes me money go out of business without paying.

    The WSJ editorial page isn’t written by economists, so the comparison is inapt–it’s a rigged game (especially since we all know how silly the WSJ editorials are).

    I hesitated to link to all of the hyperinflation and spiraling interest rate discussions over at Cafe Hayek. I figured a cute quote might be better than that can of worms.

    Not that I ever read the NYT, but I suspect a comparison of its’ editorials with the arguments of any leading economist might not shine so favorably on them,either.

    I don’t think that the WSJ holds up well against anybody, even NYT on economic prognostications. It doesn’t help them that the very person Frum was referring to is playing for the NYT team. As for leading economists, it’s surprising how few have put up serious public predictions. Plenty of talking-head economists have, and not surprisingly, many of them were totally wrong without any apparent cost to their reputations.

  14. James Hanley says:

    I find it curious that I haven’t seen a survey of businesses that asks more directly about this. It would be pretty easy to build into a survey. That wouldn’t prove that uncertainty is actually driving things, but it would at least tell us whether or not it’s seriously in businessmen’s minds.

  15. Troublesome Frog says:

    The only major regular study that I’m aware of is the NFIB study, but I’m not 100% on board with the results for a few reasons:

    1) The question is what the “most important” problem is. That means that edge conditions (like a minor improvement in one variable) can cause another variable to suddenly look much worse. They’re measuring relative results and then plotting them on a scale over time that implies an absolute.

    2) It’s hard to separate feelings from fact. I note that variables often change sharply with changes in administration even before changes in policy. This says to me more that business owners may be responding to perceived political climate rather than actual (or even proposed) changes in the variables in question.

    You could argue that (2) is a good measure of the “uncertainty” variable, but it also implies that there isn’t much we can do about it except to consistently elect only politicians the survey responders find emotionally soothing, regardless of their actual policies or rhetoric. If The Whammy is real and significant, I’m not sure what can be done about it except to try to ensure that measurable improvement in first order variables distracts people from their intuitive worry about second and third order variables.

    The “feelings vs fact” problem is probably one you know more about than I do. I’d be interested in your response to the common “50% of households pay no federal income tax” meme that is so strong today. Whether this is good or bad, I suspect that a lot of the people who find that fact morally outrageous are in that 50% and are not aware of it.

  16. Matty says:

    “50% of households pay no federal income tax”

    This doesn’t smell right to me but assuming for the sake of argument that it is true I’d be a lot more outraged by the idea that 50% of households have an income below the tax threshold, that can’t be good for anyone involved.

  17. Dr X says:

    I watched Sachs last night on Charlie Rose. Yes, he’s doing his own thing and doesn’t quite fit into the templates currently being argued, but I find some of what he says worth pondering. He emphasizes our short election cycles, which lead to lots of one-year gimmicks, but no long-term structural improvements that would lead to greater stability. Well, I won’t argue it for him. I think it’s worth watching. Rose doesn’t let you link to the specific video, but for today at least, the Sachs interview is on the right side of the page.


  18. James Hanley says:

    50% of households pay no federal income tax meme

    Eh? I guess I need to pay more attention to politics, because I haven’t been hearing this. (Truthfully, I don’t follow the news closely–I just look for stuff I’m interested in.) But apparently it’s true.

    Conversely to what Matty says, though, since both the poverty line and tax rates are set politically, it could be argued that having a large proportion of households not pay income taxes–leaving those contributions to the upper 50%–is not necessarily an outcome liberals should object to.

    I don’t know what I think about it, though.

  19. Matty says:

    Of course!
    I was thinking of the tax threshold as the level below which you have so little that taking any of it in tax would leave you unable to survive. If you instead think of it as a politically determined and esentially arbitrary point, which makes far more sense, then my objection disapears.

    In fact I’ll go further now I’ve thought about it. For the working poor raising tax thresholds so they keep more of their wages can have the same advantages as supplementing those wages with benefits and the added bonus of being less bureaucratic and intrusive.

    I repudiate my former position.

  20. Troublesome Frog says:

    It’s not really something that liberals are the ones complaining about. It’s usually brought up whenever somebody proposes raising income taxes on top earners, trying to make the argument that half of the country is freeloading already. Of course, it carefully filters out the other taxes that the bottom 50% pay and exactly what that works out to as an effective tax rate.

    The reason I brought it up is as an example of people working off of a feeling, “Blargh! Half of the country is freeloading off of my taxes!” that may not be fully consistent with reality. I’m willing to bet that many people see the taxes taken out of their paycheck every two weeks and assume that it’s all “income tax” and that they’re among the dutiful 50% that is carrying “the freeloaders” when in reality, they’re below the income cutoff for paying net income tax. (IMO, this seems like a good argument for the “tax receipt” idea.)

    Likewise, I suspect that a lot of antipathy toward “red tape” and “regulation” is really a feeling driven by political preconceptions and tribalism rather than identifiable regulation. Look at the gun rights debate as a similar example. As far as I can tell, Obama has more or less ignored guns, but you still see the, “Now more than ever, our gun rights are under attack!” rhetoric as though policy has changed in a major way.

  21. Matty says:

    While we’re on the subject of tax can anyone who knows the subject explain the flaws in the following proposals.

    1.Have one (progressive) tax for all income – wages, profits, dividends, interest, gambling wins etc.
    2. Levy this tax at the point the money accrues to natural (as oppose to corporate) persons.
    3. Set up a negative income tax as follows. The tax threshold is set at the level of what you want the lowest income in your society to be. Anyone who makes over that pays tax anyone below gets an annual or monthly payment of the difference between their income and the threshold. This payment replaces other forms of government assistance to the poor.

  22. Troublesome Frog says:


    I think that 1 and 2 are a great starting point. Unlike many on the left, I’ve never been a big fan of corporate income taxes. That money has to get to real human beings sooner or later, so why not dump the distortionary corporate income tax and start treating dividends and capital gains as ordinary income? Most of the really crazy tax hanky panky is done at the corporate level anyway. Removing absurd deductions like the mortgage deduction would be great as well. There may need to be a handful of exceptions or exemptions for weird edge cases (for example, allowing people to average over 3 years to average out a windfall) but it seems to me to be a simple and sensible system.

    The minimum income idea is a little bit sticky. The problem isn’t so much with the basic concept but rather what happens at the edges between self sufficiency and reliance on the public program. Every decision is made at the margins, so we would have to be careful not to set up a system where an hour of not working pays, say, $9 and an hour of work pays $10. In cases like that, any rational person would say, “Do I really want to work for $1 per hour?”

    A social safety net is important, but any system that might increase the incentive not to pull one’s own weight has to be carefully designed in order to be effective.

Comments are closed.