The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away.
— John Maynard Keynes, The General Theory of Employment, Interest and Money (1935), Signalman Publishing. Kindle Edition, 2010, p. 23.
These are the concluding remarks from Keynes’s seminal Book I, Chapter 3, “The Principle of Effective Demand.” The crucial fact he noted is “the drag on prosperity which can be exercised by an insufficiency of effective demand.” Importantly, this was not his own original idea. He found the essence of it in his considerable review of the history of political economy. It was through T.R. Malthus, in his early 18th Century debate with David Ricardo, that: “the notion of the insufficiency of effective demand takes a definite place as a scientific explanation of unemployment.” (The General Theory, p. 240):
I distinctly maintain that an attempt to accumulate very rapidly, which necessarily implies a considerable diminution of unproductive consumption, by greatly impairing the usual motives to production must prematurely check the progress of wealth.
By wealth, as the term was used in classical economics by Smith, Ricardo and Mill, Malthus meant tangible output. Keynes quickly turned to the 1889 text by J.A. Hobson and A. F. Mummery, The Physiology of Industry, which Keynes hailed as a reawakening of “theories of under-consumption” (Id.)
Though it is so completely forgotten to-day, the publication of this book marks, in a sense, an epoch in economic thought. (p. 241)
They attacked the premise in the theory of Smith and Ricardo that:
Saving enriches and spending impoverishes the community along with the individual, and it may be generally defined as an assertion that the effective love of money is the root of all economic good. Not merely does it enrich the thrifty individual himself, but it raises wages, gives work to the unemployed, and scatters blessings on every side (pp. 241-242).
This, you may recognize, is the familiar “trickle-down” theory. Hobson and Mummery rejected that idea, arguing instead:
Our purpose is to show that these conclusions are not tenable, that an undue exercise of the habit of saving is possible, and that such undue exercise impoverishes the Community, throws laborers out of work, drives down wages, and spreads that gloom and prostration through the commercial world which is known as Depression in Trade.
In other words — and this was the main point of Keynes’s General Theory — depression is the proximate result of declining effective demand. But Keynes’s correct view did not survive the 1960s and 1970s. I say this to anyone uncertain about the invalidity of the classical and neoclassical rejection of the principle of effective demand: I can find no valid evidence — any evidence at all in modern economic history — supporting either Say’s Law (“supply creates its own demand”) or the trickle-down theory (accurately re-framed thus: “more wealth at the top automatically increases supply, which then creates its own demand”).
CBO Adopts “Trickle-Down” Ideology
Re-posted here is the discussion of CBO forecasting from my last post. Before getting to that, I want to remind the reader that CBO in its July 2014 Outlook (Ch. 6, p. 70) formally adopted the trickle-down and austerity doctrines as articles of faith (For a fuller discussion, see my recent post “Breaking News: CBO Infected with Trickle-Down Disease”):
- “Higher debt crowds out investment in capital goods and thereby reduces output relative to what would otherwise occur”;
This is the now discredited Reinhart/Rogoff theory supporting the “austerity doctrine,” a trickle-down variation asserting that reduced national government spending (effective demand) promotes growth (i.e., “creates its own demand.”)
- “Higher marginal tax rates discourage working and saving, which reduces output.”
This is the “Laffer Curve” argument, the converse of the trickle-down myth (i.e., because more wealth at the top from reduced taxation automatically increases supply, which then increases demand, it follows that less wealth at the top caused by higher taxation, reduces growth.)
Let’s be clear about this: The agency charged with providing objective advice to the U.S. Congress about future income growth expectations has formally concluded that demand has no effect on growth, and adopted the even more fanciful myth that growing demand is created by the mere existence of supply.
We must remember how dramatically the trickle-down fantasy has been disproved. This is from my post “Amygdalas Economicus: Perspectives on Taxation,” January 24, 2013:
In their April 27, 2001 report “The Economic Impact of President Bush’s Tax Relief Plan” (The Heritage Foundation, Center for Data Analysis Report #0101, April 27, 2001, here), D. Mark Wilson and William Beach predicted that the Bush plan would significantly increase economic growth and family income while “substantially reducing federal debt.” In fact, they predicted, the Bush plan would greatly increase government revenue, so much so that “the national debt would effectively be paid off by FY 2010.” In other words, they argued that the Bush tax cuts would more than pay for themselves, by an incredible amount.
What actually happened, however, is that the federal debt, which was at about $6 trillion in 2001, increased to about $13.6 trillion by the end of 2010 (Treasury Direct, here). The Heritage Foundation’s estimate of supply-side “stimulation” was off by almost $14 trillion, nearly one year’s GDP.
To make that forecast a reality, the deficit would have to have been converted into a surplus, which meant that by a wide margin the tax cut would have to have paid for itself. Not only that, but the surplus would have to have been sufficient to retire over $6 trillion of debt in 8 years. It is difficult to accept that anyone could be stupid enough to believe that propaganda, so we can only assume its conjurers simply hoped to fog it by an ignorant, inattentive public.
But the propaganda continued when Paul Ryan issued the House Budget Committee’s Fiscal Year 2012 Budget Resolution on March 20, 2012, entitled “The Path to Prosperity: A Blueprint for American Renewal” (here), and an endorsement of the plan was released on the same day by James Pethokoukis of the American Enterprise Institute (here). As I discussed:
The proposal was to keep the Bush tax cuts, and reduce taxes on top incomes even more (there would be only two tax brackets, 10% and 25%) and reduce the corporate rate from 35% to 25%, while funding these cuts by slashing federal programs. There was no explanation of how, exactly, this austerity program would stimulate growth, but the prediction was graphically displayed that, without these tax cuts, debt would rise to 300% of GDP by 2050, yet with them the entire federal debt, which was then over $16 trillion, would be paid off by 2050:
This time, the degree to which the proposed tax cuts would allegedly more than pay for themselves became astronomical: Without those cuts, the graph predicts, the debt would rise to about 300% of GDP by 2050. So these tax cuts would produce additional government revenues on the order of $45-50 trillion!
CBO’s False Forecasting
With this background in mind, let’s review the discussion of CBO forecasting from my last post:
Of course, no one has a crystal ball, and CBO in its “Budget and Economic Outlooks” suggests that we not regard its “projections” as forecasts. But we do, because we think they are capable of making at least short-run forecasts. Paul Krugman confirms that expectation when he says (in “The Fiscal Fizzle”) things like this:
The budget office predicts that this year’s federal deficit will be just 2.8 percent of G.D.P., down from 9.8 percent in 2009. It’s true that the fact that we’re still running a deficit means federal debt in dollar terms continues to grow — but the economy is growing too, so the budget office expects the crucial ratio of debt to G.D.P. to remain more or less flat for the next decade.
And he relies entirely on the CBO to claim this:
I’m not sure whether most readers realize just how thoroughly the great fiscal panic has fizzled — and the deficit scolds are, of course, still scolding. They’re even trying to spin the latest long-term projections from the Congressional Budget Office — which are distinctly non-alarming — as somehow a confirmation of their earlier scare tactics.
All that supply-side “forecasting” can hope to accomplish, however, is guess the degree to which future growth will track the economy’s “productive potential,” which no macroeconomic forecaster actually has any way of identifying. We saw that in spades in our review of Thomas Piketty’s book “Capital in the Twentieth Century,” which attempted to resurrect an antique, controversial production-function model as the “Second Fundamental Law of Capitalism.” (See my post series “Picking Piketty Apart,” including “His Contribution,” 6/14/2014, “His ‘Laws of Capitalism’,” 6/21/2014, and “Time’s Running Out,” 6/23/2014). He candidly conceded that the model could not be used for forecasting, and explained it was only “valid” in the long run, which left me and others at a loss to explain why he decided to write a book about it.
What’s more, income (GDP) data contain a great deal of economic rent, which has zero tangible value. The point is, the only hope for making any predictions for the future is to follow trends in aggregate demand, and supply-side forecasters do not do that. Thus, the entire neoclassical paradigm unravels as we drift deeper and deeper into recession and depression.
What CBO does, it turns out, is first decide how much optimism it can sell, then unveil numbers for a basic ten-year forecast reflecting that degree of optimism. In its February, 2014 “Outlook”, for example, it projected a rapid return to an indefinite continuation of 2.1% annual growth, even though (by S&P’s calculation) growth has averaged only 1.4% over the last decade. Then it generated numbers for the intervening years and presented them as if they were the product of some sort of prognostication. In other words, CBO is actually backcasting, not forecasting!
Item 2013 . . . . 2017 . . . . 2022
1. Y-E debt, as a % of GDP  72.1 72.3 76.8
2. Publicly held debt  11,982 14,507 19,001
3. GDP  16,627 20,054 24,746
4. Computed GDP (l 2/l 1) 16,619 20,065 24,740
 Table 1-1, p. 9
 Table 1-2, p. 12
The numbers check. There is no reason to suspect, reading these numbers, that CBO isn’t using algorithms that project either publicly held debt or GDP as dependent variables. However, when we go back two years and look at data from “The Budget and Economic Outlook: 2012-2022” (here) pdf (here), we see that it does no such thing:
Item 2013 . . . . 2017 . . . . 2022
1. Y-E debt, as a % of GDP  75.1 68.5 62.0
2. Publicly held debt  11,945 13,509 15,291
3. GDP  15,914 19,708 24,665
4. Computed GDP (l 2/l 1) 15,905 19,721 24,663
Alternative Fiscal Scenario
Item 2013 . . . . 2017 . . . . 2022
1. Y-E debt, as a % of GDP  77.8 84.0 94.2
2. Publicly held debt  12,374 16,560 23,232
3. GDP  15,914 19,708 24,665
4. Computed GDP (l 2/l 1) 15,905 19,714 24,662
 Table 1.7, p. 22
 Table 1.3, p. 10. Note: No separate GDP was provided for the A.F.S.
. . . . . . . .
The entire outlook revolves around a judgmentally presumed amount of growth that will take place over the next ten years no matter what else happens. In its February 2014 report, CBO presumed a GDP of $24.7 trillion in 2022. This is up slightly, but still rounding to $24.7 trillion it used in its January 2012 outlook two years earlier.
Incredibly, this GDP number was not allowed to change, whether the debt was seen as rising to $15.3 trillion or to $23.2 trillion! This preposterous approach renders the entire “outlook” meaningless and nonsensical. The amount of debt is integrally related to GDP — at a very minimum, income tax revenues vary with GDP, so an additional $8 trillion of debt needed in the A.F.S. automatically implies a gigantic decline in GDP, and the associated need for more borrowing.
This approach is fatally pernicious: For any given higher A.F.S. level of “projected” debt, GDP is necessarily lower than presented in the report.
There is no indication that CBO believes debt might go up because the federal government will grow substantially, or that if it did there would be no stimulus, and the constant presumption of GDP growth invalidates the figures for debt as a percent of GDP. But Because CBO is backcasting from a presumed GDP ten years down the road, its numbers simply bear no relation to what may happen in the next few years, and will obscure the likelihood of impending crisis.
CBO has conceded it made as optimistic an assumption for growth as it could for the next ten years. But it’s only playing “pin the tail on the donkey,” then waiting around to see what actually happens. In the meantime, from the perspective of its economic “outlook,” no actual changes in the rate of growth, no amount of decline in income or consumer and investment demand, are allowed to modify the ultimate expectation of growth built into the GDP presumed for the end of a decade. [Note #1 – omitted here]
CBO might protest that it is constantly revising it projections to reflect real changes in economic conditions. It appears not, but if so, that is all it is doing. It should stop pretending to see ten years into the future, certainly not 35 years into the future, and then disclaiming its work as non-forecasting.
Some immediate points:
It’s unclear why the amount of public debt, which now officially exceeds $17 trillion, is reported at much lower levels by CBO. Perhaps the $17 trillion number includes some debt not held by the public? This needs clarification. [Note #2 – omitted here];
CBO’s long-range “Outlook” in July of 2014 said debt would reach 100% of GDP finally in 2039. In 2012, Reinhart and Rogoff reported it was almost already there;
Regardless, CBO has no handle on the growth rate of debt because it does not account for changes in spending and demand, only potential production;
Its assumption of 2.1% annual growth instead of 1.4% or less is unfounded, admittedly optimistic, and dangerously over-optimistic because we’re in an unacknowledged depression.
Although we do not need to worry about the national debt itself causing decline, we now know that the inequality caused by the high level of debt does, and the escalating inequality spiral will continue to depress growth even more rapidly than would the operation of Keynesian dynamics alone.
The one factor that any forecaster should be most certain of, at least in the short run, is the amount of debt and debt interest. As my letter to the Times Union reported, even under its optimistic scenario for GDP growth, CBO had debt interest exceeding the entire defense budget by 2021. It further covered up its expected growth of debt interest in the July report. There has to be some reason or reasons why CBO is unwilling to frankly discuss the debt problem any more. Could that reason possibly relate to the reason(s) that S&P suddenly surfaced a week or so later with the warning that inequality depresses growth?
The Perverse Bias in CBO’s Approach
I noted late yesterday (10:30 p.m. on 8/27) that CBO had just released “An Update to the Budget and Economic Outlook: 2014-2024” (August 2014, here), which I have yet to thoroughly review. I did make a couple of initial observations:
- CBO said it has reduced its estimate of the 2014 budget deficit. But on p. 6 it also stated: “The agency has significantly lowered its projection of growth in real GDP for 2014, reflecting surprising economic weakness in the first half of the year. However, the level of real GDP over most of the coming decade is projected to be only modestly lower than estimated in February.” This sentence, I noted, re-enforces the false impression CBO gives of actually projecting GDP over ten years (or more) as a dependent variable, and obscures its actual method of forecasting.
- I noted that this latest report has 2022 GDP at $24,565 billion, just $181 billion lower than its February 2014 projection of $24,746 billion, cited above. So even though CBO has “significantly lowered its projection of growth in Real GDP for 2014”, it has not allowed any modification of the presumed level of ten-year growth.
We need to be clear about the implications of CBO’s approach. Like its Alternative Fiscal Scenario in 2012, this change in growth expectation does not impact the final expected GDP at the end of ten years. That is because this ending level of GDP was never forecast, it was presumed:
- Perversely, no reductions in growth expectations are allowed to alter this final expectation. Because lower growth entails lower government revenues, a revised baseline would show higher deficits, debt and debt interest throughout the decade. Instead, CBO somehow arranges for additional growth later in the decade so that the amount of GDP at the end does not change.
- Misrepresenting the state of the economy and the budget this way is certainly irresponsible. It would seem to meet the political requirements of a Republican Congress that is concerned in this election year about pressure for more progressive taxation. After the election, if the Republicans take over both the House and the Senate, they can proceed unmolested with bills to reduce taxes, and continue to attack President Obama’s vetoes with charges that he is interfering with the “path to prosperity.”
- The approach requires the continuing acceptance of trickle-down ideology by an uninformed and unwary public.
Worse, using this trickle-down approach prevents CBO from making anywhere near accurate baseline projections in the first instance, thus further covering up the pace at which grave danger may be approaching:
- While it is busy obscuring the effects of any budget changes on growth, and vice-versa, CBO neglects to inform either its baseline or alternative scenarios with the impacts of changing levels of consumer or investor demand. Unless Keynesian insights are restored, the next great depression will blow in as unanticipated as the last one.
- Already, CBO has ignored the fact that for the last ten years average growth has been 1.4%, simply desiring to be as optimistic as they think possible; the world is led to believe CBO has some legitimate reason to believe that growth will improve, but that belief is founded on nothing more than neoclassical ideology.
- The most severe demand-side cause of decline is growing income and wealth inequality, because the effect of hundreds of billions of dollars of wealth transfers annually to the top is to impoverish the active economy, to a degree vastly exceeding the effect of business cycle swings in savings and investment. Neoclassical supply-side forecasting is blind to these developments.
- CBO has now been alerted by S&P of something we already knew — that inequality suppresses growth. If CBO does not respond soon by renouncing its adoption of trickle-down economics, we can only assume that its bias and deception are intentional and will continue.
So far as I am aware, CBO has made no serious effort to counter the public perception that it is actually forecasting future growth:
- Paul Krugman, as noted above, actually has the impression that CBO has a factual basis for projecting “the crucial ratio of debt to G.D.P. to remain more or less flat for the next decade.” CBO has made no such finding. It has simply decreed that it will;
- The political Right has wasted no time reaffirming that perception. The Wall Street Journal, on the same day the report was released (“Deficit Forecast Trimmed as Rates Stay Low,” by Damian Paletta, WSJ, August 27, 2014, here), highlighted the updates along with this graph showing the deficits “projected” out through 2024:
The WSJ presents these projections as if they were the product of actual forecasts, not numbers derived from a presumed level of growth. Paletta presented a middling assessment similar to Krugman’s, opening with “The agency now expects growth of 1.5% [in 2014] reflecting ‘the surprising weakness in the first half of the year’.” CBO is said to have “an upbeat view on economic growth in the next few years,” and: “The darkest clouds . . . for the next decade came in its warning about the continued growth of the federal debt.”
There is no sense of alarm in this report, even though CBO does not foresee any year for the rest of the decade when the deficit will be outside of the $500-$1,000 billion range. CBO has said this is a trend that cannot be “indefinitely” sustained, which is obvious, but it it has expressed no concern about the prospects of the trend being sustained through 2024, and in the July report it even pretended to believe the trend could be sustained to 2039. But how could that be even remotely possible? How long might we expect this trend to last, and why? In its July report, CBO clearly covered up the implications of its February “forecast,” as discussed in my letter to the Albany Times Union, and that is not a good sign.
Given what we now know about CBO’s false “forecasting,” we should have no confidence any more in any of its pronouncements. Even its rosiest, handpicked scenario for the next decade looks bleak. Paul Ryan and CBO should be called out now on their trickle-down games — before the election.
JMH – 8/28/2014