Whose Economy is it, Anyway?

Any time there is positive economic news, politicians and their supporters feverishly attempt to take credit. It’s unsurprising; political incentives are strongly aligned toward claiming responsibility for beneficial social outcomes while deflecting or redirecting the negative or questionable ones.

Despite predictions for all manners of economic apocalypse if the current President were to be elected (a handy compendium can be found here), at the current rate of expansion – near “full” employment, estimated GDP growth at 4.2% (2nd qtr 2018), and business confidence soaring - a fierce battle has been joined to claim responsibility for the current economic boom.

A litany of resolutely partisan sources have entered the fray on either side. Yet for no less than five reasons the entire exercise is moot, while nevertheless valuable both as a sort of political Rorschach test and as a gauge of general economic education.

Lags

Lag is the amount of time taken for a policy action to impact the economy. It’s usually divided into “inside” and “outside” lags, where inside lag is the time between when a downturn is noticed (recognition lag) and action is taken (implementation lag); outside lag is the amount of time that passes between when the action is taken (rates lowered/raised, fiscal stimulus passed) and changes begin to materialize in the economy.

The inside lag of fiscal stimulus tends to be longer than that of monetary stimulus (Congress has to decide on a bill, pork has to be added, a vote has to take place, etc.), but the outside lag is shorter. Monetary policy can be implemented very quickly (short inside lag) – intra-meeting FOMC actions have occurred – but the effects take longer to manifest (longer outside lag). Also, fiscal stimulus is more “targeted”, specifically impacting certain tax brackets or industries (missing or penalizing others), while monetary stimulus has more general, economy-wide effects.

But while research has attempted to determine the length of fiscal (Schmidt & Waud, Taylor, Blinder, and others) and monetary lags (Friedman, Gruen, Bernanke, Batini & Nelson, and many others), the only consensus is that they’re variable and in part determined by the specific nature of the downturn at which they are directed.

Add to this that dating the starts and ends of recessions is a subjective enterprise at best, and one begins to see the difficulty of crediting the economic policy decisions of one political regime over another/others.

Questionable efficacy

Further, the actual effectiveness of government stimulus programs is mostly unknown and perhaps unknowable: econometric efforts to link government spending with changes in GDP, unemployment, or other economic metrics are notoriously difficult and subject to problems in ascertaining causality, assessing interactions, and accounting for hidden variables. A major measure of the effectiveness of a fiscal or monetary policy implementation - the multiplier - is not only difficult to measure, but obscures inevitable long-term costs. As a recent meta-analysis summarizes,

Recent researchers found a wide variation of expenditure multipliers. In some cases the multiplier was negative, which means that stimulus spending reduced GDP. In others, the multiplier was as high as 2.0, meaning that a $1 increase in spending led to a $2 increase in GDP … There is more to either story – far more. First, the government targets stimulus spending to particular occupations and sectors, such as teachers, first responders and healthcare workers. The choices reflect the public choice realities of gaining and keeping off. In any case, targeted stimulus causes distortions in the favored sectors through a displacement of resources form those sectors not favored … Then, at some point, the stimulus funds must be paid for, or the associated debt must be refunded by issuing new debt to pay off old debt.

Simultaneous causality

A better term for this factor is endogeneity: it is as correct to say that fiscal or monetary stimuli affect the economy as to say that the state of the economy upon arrival determines the effectiveness of the fiscal or monetary initiative. Every economic initiative is preceded, and not usually by much time, by another.

For example: as to the matter of whether the Obama Administration’s $800B American Recovery and Reinvestment Act (Feb 2009) was responsible for reversing the so-called Great Recession, one could as easily cite the Bush Administration’s Economic Stimulus Act of 2008 (Feb 2008) as either paving the way for, or hindering, the former.

The Nature of the Presidency

The Federal Reserve controls monetary policy, ostensibly independently. Congress controls fiscal policy. The President has to sign bills into law, but political incentives are strongly tied to “doing something” even when the best policy might be to not intervene.

The President is one individual, and the actual contribution of any President is negligible. The most visible public servant in the government is typically the most polarizing and readily subject to opprobrium. But both practically and in terms of enumerated duties the Chief Executive has few direct means of influencing the economy. A tone can be set through appointments, public speeches and Executive Orders, but it would be fairer to cite the machinations within Congress as more potentially impactful.

Democrats vs. Republicans

But isn’t it a matter of fact that Democrats tend to preside over better economies than Republicans? Yes, but for no discernible reason. An exhaustive study by Blinder and Watson found that despite a +1.8 percentage gap of GDP growth during Democratic control of the White House over Republicans,

[m]uch of the D-R growth gap in the United States comes from business fixed investment and spending on consumer durables. And it comes mostly in the first year of a presidential term. Yet the superior growth record under Democrats is not forecastable by standard techniques, which means it cannot be attributed to superior initial conditions … Democrats would no doubt like to attribute the large D-R growth gap to better macroeconomic policies, but the data do not support such a claim. Fiscal policy reactions seem close to “even” across the two parties, and monetary policy is, if anything, more pro-growth when a Republican is president—even though Federal Reserve chairmen appointed by Democrats outperform Federal Reserve chairmen appointed by Republicans. It seems we must look instead to several variables that are mostly “good luck.” … These three “luck” factors together (oil, productivity, and ICE) explain 46-62% of the 1.80 percentage point D-R growth gap. The rest remains, for now, a mystery[.]

What is an economy?

None of this considers that recessions do not, in and of themselves, indicate policy failure: the two brief but sharp recessions which struck in the opening years of Reagan’s first term were a painful but essential price to pay for ending the stagflation of the 1970s. Nor that nearly every Presidential Administration going back three generations has either entered or left office with a recession underway.

In fact, the U.S. economy is growing due to the actions of hundreds of millions of individuals, domestic and foreign, acting individually and through firms: voluntarily producing, consuming, and exchanging goods and services. It is individuals who recognize opportunities, transact, engage others through markets and - when fearful of loss - withdraw from same until conditions seem favorable again. The economy is not a machine that occasionally “breaks down” and requires a mechanic or engineer to “fix” or restart it; it is a massive, organic, ever-evolving social network defined by inter-related production and consumption functions: ceaselessly converting information into decisions which impact the allocation of resources.  

One thing is certain: when the current economic environs inevitably shifts and cools, a season of blame and deflection will again take wing. But no intellectually honest, academically-informed opinion will settle upon one President or another as culprit or hero; the essence of economics is far too complex to accredit to a politician.

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Peter C. Earle

Peter C. Earle is an economist and writer who joined AIER in 2018 and prior to that spent over 20 years as a trader and analyst in global financial markets on Wall Street. His research focuses on financial markets, monetary issues, and economic history. He has been quoted in the Wall Street Journal, Reuters, NPR, and in numerous other publications. Pete holds an MA in Applied Economics from American University, an MBA (Finance), and a BS in Engineering from the United States Military Academy at West Point. Follow him on Twitter.