March 12, 2013
Assessing the Economics of the Ryan Plan
CBO finds that reducing budget deficits, thereby bending the curve on debt levels, is a net positive for economic growth. CBO finds a dichotomy, however, between the short-term and longer-term impacts of deficit reduction. For instance, CBO’s short-term economic models are driven mainly by demand-side factors. According to these short-term models, deficit reduction that lowers government spending leads to a temporary reduction in economic output due to the assumed reduction in consumption as a result of lower government transfers. These models assume government spending has a “fiscal multiplier” in excess of 1, meaning that its reduction leads to an outsized reduction in overall economic output. Of course, every dollar the government spends must be taxed or borrowed from the private sector.
Although CBO believes that deficit reduction may lead to lower economic growth over the short term, some economists offer a contrasting view. They argue that a country’s debt build-up can be so large that longer-term fiscal concerns essentially start to bleed into the present, affecting short-term economic activity. The extreme example is a sudden, full-blown debt crisis like the one that fiscally troubled countries in Europe have experienced. But there is also a less-noticeable, slowly evolving type of crisis that can grip a debt-burdened economy—the crisis of uncertainty and waning confidence in the will of policymakers to deal with the government’s unsustainable fiscal trajectory. Investors and businesses make decisions on a forward-looking basis. They know that today’s large debt levels are simply tomorrow’s tax hikes, interest-rate increases, or inflation—and they act accordingly. It is this House Budget debt overhang, and the uncertainty it generates, that can weigh on growth, investment, and job creation.
For instance, Stanford economists John Cogan and John Taylor recently studied fiscal-consolidation strategies that use a so-called “Neo-Keynesian” economic model to take into account how consumers and businesses might react to a country’s future fiscal trajectory. For example, forward-looking consumers and businesses may expect future tax hikes, and plan accordingly, if a country continues to build up large amounts of debt that will ultimately need to be paid off. In this study, Cogan, Taylor, and their fellow authors find that “even in the short-run, the consolidation of government finances is found to boost economic activity in the private sector sufficiently to overcome the reduction in government spending.”66
- No reference to Heritage CDA analysis of the plan, as opposed to the version two years ago. For entertainment, see    
- Reference to a “Neo Keynesian” model. Not sure what that is, although this is what Wikipedia says. I think Representative Ryan means to refer to a “New Keynesian” model.
- Footnote 66 refers to the “Fiscal Consolidation Strategy”. The authors use a New Keynesian DSGE to simulate out the implications of fiscal consolidation cited in the plan. I can’t claim to have carefully read the entire paper, but I can’t figure out what is assumed for monetary policy – which is somewhat important if one is considering the short run impact as well as the long run effect (see this paper).
- The model has immediate effects from fiscal consolidation. That’s because in the long run, the model is Ricardian, despite the short run rigidities introduced by sticky prices and rule-of-thumb consumers. As I’ve noted here, not all NK DSGE’s have this characteristic.
- A small point. CBO does not assume all fiscal multipliers are greater than one, as documented in innumerable reports (what’s the point of full disclosure if nobody reads!). As I’ve observed (e.g., ) some transfers multipliers are less than unity (as theory suggests they should).
- On a lighter note, I particularly liked the sentence: “Although CBO believes that deficit reduction may lead to lower economic growth over the short term, some economists offer a contrasting view.” It reminded me of the TV show “Ancient Aliens” where the narrator observes that some people believe “X” (Nazca lines are signs to folks from Orion, etc.). While I’m sure that there are some serious economists who do believe in the contrasting view (e.g., Taylor, Wieland), it would’ve been more honest to note where the preponderance of views in the economics profession lies.
Posted by Menzie Chinn at March 12, 2013 09:35 AMdigg this | reddit
Just wondering how much credence can be given even to the long run estimates if the model becomes Ricardian? Does it really say anything that is meaningful?
Posted by: Dan Mulligan at March 12, 2013 10:13 AM
How can anything be rationally modeled if the assumptions include unspecified revenue changes? AFAIK and certainly as we went through last time round, there is a drop in rates but no detail about what makes up for the drop in rates. The modeling was junk and I don't have the patience for it this time.
Posted by: jonathan at March 12, 2013 10:25 AM
• No reference to past Democrat budgets either – oh, that’s right there have been no past Democrat budgets.
• From Wiki Answers: The word neo means new. It is derived from the Greek word neos, which means young, fresh, new or recent.
• If it is assumed there will be no change in monetary policy why bother. Only those addicted to the narcotic of money worries about the next fix.
• Sounds like you agree that the statement about fiscal consolidation is true.
• The statement does not say the CBO assumes all fiscal multipliers are greater than one, only those that use models that forecast a reduction in economic output due to a reduction in government spending. This is simply math.
• The preponderance of the economics profession is made up of quacks. Perhaps the statement should have revealed that most have been wrong through this entire economic crisis.
Posted by: Ricardo at March 12, 2013 10:29 AM
Ricardo: Regarding fiscal multipliers, if you are right in what the Ryan budget is saying, then it is wrong, AGAIN. If you could draw the graphs, then you'd know that even if the multipliers are less than unity (say for transfers), cutting expenditures would reduce GDP.
Regarding your assertion that the preponderance of the economics profession being quacks, I wonder who wrote this gem:
"More important than estimating the cost of the war is estimating the cost if there were no war. What would be the cost of a 9-11 event every 3 to 4 years? Granted there is no evidence that Iraq was directly involved in 9-11, but Iraq was involved in 9-11 through providing training bases, military leaders meeting with Al Qaeda prior to the events, and Saddam giving monetary support to militants worldwide. That is not to mention how much classified information we got from Saddam's spider-hole. Naivet� prevents connecting the dots which leads to a repeat of 9-11.
The war was not justified with one 9-11. Would it be justified with two, three, more? When is our system of government worth fighting for? Never?"
Why, it was you in your DickF incarnation. I (and other readers) are supposed to take your assessments of economists when you can't even get facts straight.
By the way, there have been Democratic budgets -- think the first year of the Obama Administration.
In any case, I hope you never stop commenting on Econbrowser. I can always figure what is true by reading what you say, and inverting.
Posted by: Menzie Chinn at March 12, 2013 11:37 AM
I love that the Cogan-Taylor paper is cited by Ryan as support of his plans. Has anyone read it? It says pretty explicitly that the authors maintain that growth will result if primarily government transfer payments are cut and funneled into labor rate tax cuts and debt reduction. Sounds okay right? Well look at their definition of "transfer payments" from page 20:
"Our NIPA-based expenditure projections are obtained by converting three large categories of non-interest federal spending into federal purchases and transfer payments. The first category consists of four main federal entitlements: Social Security, Medicare, Medicaid, and health insurance subsidies under the Affordable Care Act. These expenditures, which account for nearly one-half of all federal spending are treated as transfers.15"
In other words slash SSN, Medicare, Medicaid, etc. and use the funds to reduce debt and cut labor tax rates. And the elderly and disabled would do do what? particularly? go back to work?
The real cause of the growth is going to be all the work in gathering up and burying all the dead old people before they stink too much.
Posted by: gary Van Ryzin at March 12, 2013 01:17 PM
"And the elderly and disabled would do do what? particularly? go back to work?"
Posted by: Buzzcut at March 12, 2013 02:11 PM
I love it! What proof do you have that anything I wrote in that passage is wrong? Simple claiming something is true without evidence is an old Progressive trick, but it is still a trick.
And you never did answer the question I posed to you. Just how many 9-11 events would it take for you to justify defending our country or would you never defend our country?
I imagine if you had been in charge during the Revolutionary War we would all be speaking English today. (For those of you with no sense of humor that, is a joke!)
Posted by: Ricardo at March 12, 2013 02:27 PM
My favorite "Of course, every dollar the government spends must be taxed or borrowed from the private sector."
But what debt? All we have to do is assume a high enough growth rate. The OMB needs to get on this now.
Posted by: Lord at March 12, 2013 03:34 PM
There is no cut in spending. Ryan's plan grows at 3.4% per year. Obama's plan is to grow spending by 5% per year. The difference between the 2 plans is that Obama spends $46T over 10 years and Ryan spends $41T.
I question the claim that GDP growth is going to average greater than 3.4% over the next 10 years in either plan.
Posted by: tj at March 12, 2013 06:21 PM
Some observations on what I learned from the observations
-if someone mentions Heritage, then mock Heritage. If someone doesn't mention Heritage, then mock Heritage.
-It's not neo-Keynesian, nor modern Keynesian, nor noveaux Keynesian, nor contemporary Keynesian. It's new Keynesian, which proves Ryan doesn't know what he's talking about.
-Footnote 66 contains a reference to a new Keynesian model that Menzie hasn't looked at carefully that may not address an issue that might turn out to be very important. Thus, we'd better be awfully suspicious of Ryan's analysis.
-The results depend on standard new Keynesian model assumptions that some non-standard models don't make. Watch out--Ryan is pulling a fast one.
-Amazingly enough, when Ryan said government spending he didn't distinguish between government purchases and transfers, which could have a multiplier less than 1. This is just the sort of oversight that calls into question the whole analysis.
-Truth in economics is not decided by who has the most compelling evidence but rather by majority vote.
Posted by: Rick Stryker at March 12, 2013 07:09 PM
Rick Stryker: The NAWM is fairly well known; I don't have a particular prbblem with the characteristics of the model, but when we are near the ZLB, it seems to me kind of important to know what is assumed with respect to monetary policy. (It seems that a Taylor rule is in the canonical version, see here, p.28) Do you disagree? If so, are you saying the simulations should be invariant to the conduct of monetary policy?
By the way, Heritage is so eminently mock-able, that I must confess I cannot resist. After all, how often can one read of an analysis: “We adjusted the full employment unemployment variable,” Beach told Weigel. “Nothing else changes as a result of that, but the employment number changes.”
Posted by: Menzie Chinn at March 12, 2013 07:53 PM
How can you mock others and ridicule others when you propose having all Americans on food stamps?
Posted by: Ricardo at March 13, 2013 05:54 AM
Yes, I do agree that it's important to specify monetary policy. The Ryan budget plan cited an earlier version of the paper that wasn't clear. In this later version,
you can see from equation (13) that it's a Taylor rule.
Heritage's goal is write analysis that influences policy. In doing so, they will necessarily disappoint an academically-oriented economist who is opposed to them. However, I think they understand the tradeoff and are comfortable with it. While you are busy making fun, they are busy making policy.
Speaking of conservative policy, it's great to see Paul Ryan back in the saddle. I have a feeling that you are going to be posting a lot about him in the coming year.
Posted by: Rick Stryker at March 13, 2013 06:12 AM
I was interested in the Cogan, Taylor, etal paper referenced in the plan. It is interesting to note that in order to get deficit reduction to increase GDP growth they had to 1) reduce only taxes on labor 2) assume that willingness to consume in the near-term increased substantially,and 3) no overhang in private debt ..details following in
Posted by: R Gregory at March 13, 2013 07:21 AM
Rick Stryker: Well then, they are assuming a Taylor rule that might imply negative target interest rates. That point should've made it into the earlier draft as all the work I've seen indicates it is important. And casts into doubt the relevance of the simulation results.
I've worked at a policy institution. I talk a lot to economists at policy institutions. One can do policy without being intellectually bankrupt. That may constitute a trade-off to you, but I think there are some who have slid down the tradeoff too far.
Posted by: Menzie Chinn at March 13, 2013 07:42 AM
I would note to TJ, Rick Stryker, and Ricardo that the Baby Boom generation will be aging, and that accounts for much of the difference between the Ryan Budgets and the 2011/12 Obama Budgets forecast spending. Aging seniors who exhaust their assets and end up in nursing care consume approximately 1/3rd of Medicaid and that % is rising. http://www.familiesusa.org/resources/publications/reports/cutting-medicaid-findings.html
The big savings in the Ryan budget is the axing of Medicaid. The savings from screwing the Environment, the unemployed, poor, disabled, and students in non-defense discretionary is used up in spending on Defense and Homeland Security along with "tax cuts for rich people."
I really don't see a big job market for 85 year olds with Alzheimer, but you guys know best. SELF-RELIANCE!!! FREEEEEEEEEEEEEDOMMMMMMMMM!!!
Posted by: sherparick at March 13, 2013 11:56 AM
Sorry, I posted the old link. The newer one is
If you look at figure 6, negative interest rates do not seem to have occurred in the simulation.
Posted by: Rick Stryker at March 13, 2013 01:50 PM
Rick Stryker: That's my point -- under some reasonable paramterizations the target interest rate using the Taylor rule is negative. That it doesn't is itself a little odd. The fact that the ZLB doesn't affect behavior of the central bank is also interesting. Finally, inspection of Figure 6 indicates some interesting and counter-intuitive results -- namely in the face of contractionary fiscal policy, the central bank tightens monetary policy (or if you prefer, raises the interest rate, as calculated by the sum of real interest rate and inflation, displayed in Figure 6).
Curiouser and curiouser...
Posted by: Menzie Chinn at March 13, 2013 03:27 PM
Doesn't seem curious at all. Interest rates are basically flat in the simulation. The initial interest rise is very slight--looks like maybe 15 basis points. I'd hardly call that tightening monetary policy.
Also, the reasons are clear and the economics makes perfect sense. The lion's share of the reductions in spending are transfers, not government purchases. Consumers react to the permanent increase in income resulting from lower government spending and lower taxes. They also work more since tax rates on labor are lower.
Posted by: Rick Stryker at March 13, 2013 04:25 PM
Rick Stryker: Sorry, to my eyes, looking at the sum of the real and inflation rates, I see around 30 bps increase in response to a fiscal contraction.
Posted by: Menzie Chinn at March 13, 2013 05:51 PM
Rick Stryker Consumers react to the permanent increase in income resulting from lower government spending and lower taxes. They also work more since tax rates on labor are lower.
Hmmmm...not so much. I believe the general consensus among labor economists is that workers are more willing to substitute labor for leisure if the wage hike is seen as temporary. Sort of the reverse of what consumers do. Wage hikes that are seen as permanent do not increase labor effort all that much...partly because there is an income effect and permanently higher wages increase future income, and one of the things you buy with higher income is more leisure.
But when the economy is at the ZLB and there's a lot of slack the problem isn't trying to coax workers into wanting to work more hours, but one of trying to find employment for all of the available workers. You seem to think it's forever 1979 with high capacity utilization, high inflation, low unemployment and an economy straining at the steep part of the aggregate supply curve.
Posted by: 2slugbaits at March 14, 2013 04:03 PM
Despite Ricardo's hyperbole (yes, it is pretty clear that lowering G will lower GDP in the short-run), he is correct on one point. Where is the analysis of the Democratic budget? And claiming that there was a Democratic budget in Obama's first term 4 years ago reinforces his point rather than refutes it. The Murray budget is now out, I'd like to see as critical a gaze turned on your own party. Otherwise any clear economic reasoning will be overshadowed by your obvious partisan tilt.
Posted by: Tom at March 15, 2013 05:36 AM
We need a post on "Assessing the economics of the status quo."
Posted by: Anonymous at March 15, 2013 07:02 AM
Ricardo: Most of the economics profession "quacks?" I guess people with your level of comprehension say the same things about medical Doctors, so Menzie must be in good company!!
Posted by: Chris at March 31, 2013 11:54 AM
Also, what am I to make of it that Ricardo only pops his troll head out when Menzie posts, and not on any of the JDH debt-interest posts? Or was he just using another sockpuppet?
Posted by: Chris at March 31, 2013 11:56 AM