Author: Keith Hennessey

(This is a guest post from the author’s blog.)

Meet the four person Jones family, which after taxes had $100,000 of income last year.  For some strange reason, 15-year old Billy Jones is not allowed to work or earn any income.  For some even stranger reason, Billy’s parents give him an allowance of about $50 per day, totaling $18,000 last year.  Billy’s parents also gave him a credit card with no apparent credit limit.  Billy spent $20,000 last year, therefore running up $2,000 of credit card debt.  (Billy is spoiled rotten.)

This year the Jones family expects to have $105,000 of after-tax income.  Billy announces that he plans to spend $21,000 this year, the same proportion of the total family income (20%) as last year.  His parents shrug and increase his allowance to $18,900, the same 18% of total family income as last year.  Billy therefore expects to add $2,100 of credit card debt this year.  He also announces that when he was five years old he promised his friends he would drive them wherever they wanted once he turned 16, so he expects his spending will soon grow by $2,000 per year.  He explains to his parents he’ll just put the gas costs on his credit card if they don’t increase his allowance.

Billy’s parents look at his credit card statements and freak out.  They realize that they co-signed his credit card application, and they are therefore ultimately responsible for Billy’s debt if he cannot pay it from his allowance.  They sit down with him to discuss how to bring his credit card debt into line.  It’s not the $2,000 of existing debt that worries them.  It’s the continued borrowing, and the expected increased future borrowing once he gets his driver’s license next year.  They are worried about Billy’s annual deficits and his growing debt.  They track his borrowing with a graph they hang on the refrigerator door.

Billy explains that if they are worried about his borrowing, the answer is simple:  increase his allowance.  That can reduce or even eliminate his future deficits.  Next year his parents need to raise his allowance by $2,000 so that his annual credit card borrowing does not increase.  It will probably be even more in future years, because he plans to have many friends and drive them many places.  Cutting his spending and increasing his allowance will both reduce his future borrowing, and Billy would prefer that his parents increase his allowance because it’s easier and less painful for Billy.  This will allow him to keep his longstanding promise to his friends.  They’re counting on him.

Billy’s parents realize that Billy’s annual borrowing, his annual deficits and increased credit card debt are not the actual problem to be solved.  Billy’s increased borrowing is a symptom of his underlying problem, which is his increased spending.  They see why it’s a mistake to focus only on the credit card debt and additional borrowing, because that leads Billy to conclude that allowance increases and spending cuts are equally valid solutions.

A little bit wiser, Billy’s parents now explain that every dollar of additional allowance for Billy means less for the rest of the family.  If Billy cuts his spending, his future annual credit card deficits will decline.  If Billy’s parents increase his allowance, his credit card deficits will also decline, but the rest of the family (including little Suzy) will suffer.  Billy’s parents explain that they care about the promises Billy has made to his friends.  They also care about the interests of the rest of the family, and they must balance those competing interests.  They tell Billy they are particularly worried about the projected future costs of his promise to drive his friends all over town beginning next year.  Maybe he needs to rethink that promise so that he does not make the rest of the Jones family suffer through some combination of higher allowances and credit card debt.

Billy’s problem is not his credit card borrowing.  It is not that his allowance is too small.  Billy’s problem is his increased spending, now and in the future.  That higher spending can be paid either by bigger allowances this year, or by borrowing more using his credit card.  Billy’s allowance and his credit card borrowing are the results of his initial decision about how much to spend.  Bigger allowances for Billy this year mean less money this year for Mom, Dad, and little Suzy.  More credit card debt will require bigger future allowances to pay it off, which will mean less money in the future for Mom, Dad, and Suzy.

Billy’s parents recognize that the combination of an allowance plus an apparently unlimited credit limit lead Billy to make irresponsible spending commitments.  They shift their attention and family debate from Billy’s credit card borrowing to his spending habits.  They make decisions about how much Billy will be allowed to spend.  Once they have decided that, they then allocate that spending between current allowance and credit card borrowing, to determine how much the rest of the family will have available to spend this year, and how much in future years.  They still care and are concerned about his annual deficits, and they still track them on the refrigerator door.  But they move that graph down to make room for another graph to track Billy’s spending habits.  They know that if they get Billy’s spending under control, then the allowances and credit card borrowing will automatically fall into place and the rest of the family’s interests will be protected, now and in the future.

Billy complains about having to cut his spending.  Billy’s friends complain even louder, and tell Billy his parents are mean and selfish for forcing him to break a 10 year old promise.  And yet as Billy’s parents consider the future of the entire Jones family, they know they are now on track to responsible family finances.

Tomorrow we will look at how Billy is spending his parents’ money and the promises he has made to his friends.

Read more from economist Keith Hennessey –>

Join the conversation about this story »

(This post appeared on the author’s blog. Keith Hennessey is the former director of the National Economic Council.)

Yesterday I guessed a two in three chance the President would have legislative success, which I now define as at least signing the Senate-passed bill into law.

In the past I have at least been able to fool myself into thinking there was a rational basis for my projections.  Now I’m just guessing.  I will stick with two in three for the moment, but I am now just picking numbers out of thin air based on some slightly informed guessing.  This prediction will be out of date by tomorrow, if not sooner.  And I do not anticipate updating it.

That’s because this is now entirely an inside game into which I have extremely limited visibility.  If the Speaker can get 216 votes for two bills, then it’s over.  But only a handful of people really know how far she is from that goal.

Since I cannot offer you genuine insight, I hope some broad observations will suffice, informed largely by my experience working for the best vote-counter in Senate history, Trent Lott.  Senator Lott once said to me, “Keith, I know you were a math major.  I’m going to teach you how to count.”

I hope you will accept these dozen observations in lieu of a real prediction.

1. The President and Democratic Congressional leaders have created an external appearance of momentum.  That is necessary but not sufficient for legislative success.
2. Public expressions of confidence mean little.  Democratic Leaders have to predict success whether they believe it or not, because those predictions affect momentum.
3. For some Members the substance matters.  (I know, that sounds terrible.)  We have not yet seen the text of Bill #2 or CBO scoring of it.  Additional risk will be introduced as soon as those become public, probably within the next 36 hours.  How many times so far have we seen CBO scoring trip up the majority?
4. There is a huge difference between needing 1-4 votes and needing 8-10 vote.  I don’t know which she is really facing.
5. Effective vote counters pick up the easy votes first, so by this time each additional vote is nearly intractable.
6. Sometimes you bring a bill to the floor a few votes shy, thinking you can close those last few votes only when the vote is occurring.  That’s a huge gamble.  You do it only when you have no better option.
7. Senate Democrats are an underappreciated wildcard, as is the Byrd rule.  Will Senate Democrats blindly accept the substance of Bill #2, or will they try to amend it before passing it?  Can Senate Republicans use the Byrd rule to force a change and therefore another House vote?  Because of these wildcard factors, House Democrats should be asking their leaders if they might have to vote again on Bill #2 after the Senate considers and possibly changes it, and maybe after the Easter Recess.
8. I wish I knew how well the House and Senate Democrats are coordinating.  I imagine the trust and execution gaps on Bill #2 are among the largest hurdles the Speaker faces.  If they are poorly coordinated, then I would expect some bumps once the legislative text is revealed.
9. The Saturday vote target is irrelevant.  They will slip it as needed.
10. If the House passes Bill #2, assume 3 days minimum for Senate consideration.  The motion to proceed is non-debatable, so that takes only 20 minutes for a vote.  Twenty hours of debate typically takes two full days, plus one more for the vote-a-rama.  House passage this Saturday would allow plenty of time for Senate consideration of Bill #2 and for completion of both bills if the Senate does not amend Bill #2.  If the Senate does amend Bill #2, then the time for a second House vote on Bill #2 could bump up against the recess deadline.  Of course, in this scenario Bill #1 is already on the President’s desk.
11. At least as of 2008, the phones still worked on Air Force One.  I believe they have working phones in Indonesia and Australia as well.  The President’s trip delay is much more about the optics of him being here (or more accurately, the downside optics if he were not here) than about his practical ability to influence votes.
12. So much for transparency.  Bill #2 is being drafted in the Speaker’s office.  So much for regular order in the legislative process, or open debate, or amendments…  As recently as two weeks ago the President was admitting that they “could have done better” on transparency.  We will never know the extent of side deals being cut to lock down votes, since many of them will be delivered outside this legislation.

Join the conversation about this story »

See Also:

• 10 Things You Need To Know About Obamacare Plan B
• If Harry Reid Uses Reconciliation To Pass Healthcare Reform, He’s Going To War With 73 Percent Of America
• We Need Real Financial Reform That Directly Ends Too Big To Fail

(Keith Hennessey was the director of the National Economic Council under President George W. Bush. This post originally appeared on his blog, keithhennessey.com.)

The recent anniversary of the stimulus law reminded me that I need to recap my views.  I will highlight a point I think is being overlooked in the historic debate and comment briefly on the pending “jobs” bills.

Recap: my views on fiscal stimulus

Unlike many critics of the stimulus law, I think that fiscal policy can increase short-term economic growth, especially when the economy is in a deep recession.  In other words, I think that fiscal stimulus is a valid concept.  This does not mean that I think that every increase in government spending, or every tax cut, (a) increases short-term economic growth or (b) is good policy.

In the world of fiscal stimulus there is a tradeoff between speed and power.  Putting money directly into people’s hands is fast – people immediately change their behavior.  We saw this on a much smaller scale with Cash-for-Clunkers:  as soon as the incentive was out there, people sprinted to the dealership to take advantage of it.  “Putting money directly into people’s hands” includes tax cuts, payments to individuals mislabeled as tax cuts, and entitlement spending like unemployment benefits and food stamps.  The challenge with these options is that if the payment stream is temporary, people don’t spend 100 cents on the dollar of the money they get.  They instead save a fairly big portion of it (probably between 60 and 75 percent).  So if you’re trying to increase short-term consumption, a temporary tax cut or temporary benefit spike is fast but not powerful.  Then again, in the current recession where many family balance sheets were decimated by a severe decline in the value of their home, rebuilding those losses with increased saving is a good thing, too.  If the Administration had instead put $862 B directly into people’s hands, you would have seen more immediate spending and economic growth than we did, even if people had saved most of it.

In contrast, government spending is powerful but painfully slow.  If the government spends $1 on building a road, eventually that entire $1 will enter the economy and increase GDP growth.  Your bang-for-the-deficit-buck is extremely high.  The problem is that bang-for-the-buck doesn’t help us if that bang occurs two or three or four years from now.  Last year’s stimulus contained $8 billion for high speed rail and $1.5 billion for intermodal transportation grants.  Not one dollar of that $9.5 billion has yet been spent.  If you look at all $48 B in transportation spending in last year’s stimulus law, as of mid-January less than 20 percent had entered into the economy.  Power does you no good if it comes too late.

There are other differences between spending stimulus and cash-in-people’s-hands stimulus.  The Administration and its allies emphasize what they see as the non-stimulus policy benefits from their increased government spending (environmental, education).  I would instead prefer that people be allowed to spend and save the money how they best see fit.  My preferred path also has less waste and bureaucracy.  These debates are unrelated to the macroeconomic questions and are a distraction from them.

As with a double espresso or an energy drink, there’s a post-stimulus letdown problem with any temporary stimulus.  We’re going to see some of that effect this year.

Last year’s stimulus law

I agree with the Administration that last year’s stimulus law increased economic growth above what it otherwise would have been.  I agree that employment is higher than it would have been without a stimulus.

At the same time, I think their estimates of how much the stimulus helped are exaggerated, confused, and misleading.  The law was poorly designed and inefficient.  The money has been slow to spend and filtered through federal and state bureaucracies.  As a result, the macroeconomic benefits were diluted and mistimed (and timing is everything in stimulus) and tens of billions of dollars are being wasted.

Most conservatives and Republicans say what they don’t like – the stimulus law.  Few argue what they would have done instead.  It’s easy for outsiders (including me) to complain about the actions taken.  Ask a critic:  If you were in charge, would you instead have done nothing?  Do you think you could have sustained that position politically throughout 2009?

Given a decision last year to do a big fiscal stimulus, I would have preferred, in this order:

1. putting all the money into a permanent reduction in income and capital taxes;
2. putting all the money into a a temporary reduction in income and capital taxes;
3. putting all the money into transfer payments;
4. what Congress and the President did.

Given the policy preferences of the President, his team’s big policy mistake last year was to let Congress turn a reasonable macroeconomic fiscal policy goal into a Congressional spending toga party.  Given his policy preferences, the President should have insisted that Congress put all the money into (2) and (3) above.  He would have had a bigger macro stimulus bang earlier.

Team Obama’s even bigger mistake was in overselling their policy.  They made the classic mistake of overpromising and underdelivering.  The political system is punishing them and their allies for this error.

Their messaging had and still has two fatal flaws:

1. They created expectations of a net result, rather than an increment.  This is the infamous graph in which they “promised” that their policy would result in an unemployment rate that would now be below 8%.
2. They are attributing whatever economic recovery is happening solely to the stimulus law.

Only the first has been sufficiently debated.  No one knows how big of a positive effect the stimulus had, since no one knows the counterfactual of what economic and job growth would have been had there not been a stimulus law.  This unknown aspect always exists.  The Administration tried to game it with their unemployment graph and their “jobs saved or created” measure, and they have gotten politically burned because of it.

The second flaw is important and insufficiently discussed.  I’ll show it with a picture.

Problem #1 above is that we can’t measure the increased economic growth since we don’t know the baseline from which we’re measuring.  We don’t know what numbers we should put in the rounded rectangle on the right.

Problem #2 is that the Administration suggests that all of that growth resulted solely from the stimulus (blue box).  It is instead the result of the natural recovery that happens in any business cycle (green box), plus the stimulus, plus all the other policies that are contributing to economic growth.  We cannot know how much of the economic recovery is the result of policy, and how much would have happened naturally in the absence of any policy changes.  We also cannot know the relative importance of various policy changes in contributing to increased economic growth.

As an example of an alternate viewpoint, I think the financial crisis beginning in September 2008 turned a mild recession into a severe recession.  The severe recession was caused by a financial wound.  I believe the most important policy actions to address the severe recession and its cause were (1) preventing the collapse of the financial system, (2) recapitalizing the banks, and (3) pumping tremendous amounts of liquidity into the financial system.  These actions (which were concentrated in Q4 2008 and Q1 2009 and spanned the Bush and Obama Administrations) treated, cleaned, and dressed the financial wound.  This put the patient on the path to a painful, slow, natural recovery.

I think that much of the recovery we have seen would have occurred even without the $862 B law, because I think the first three white boxes and the green box are what mattered most.

Fiscal stimulus could have helped a lot more than it did had it been designed correctly.  And I do believe that it was a contributing factor, but nowhere nearly as much as the Administration would have you believe.

Reasonable people can disagree on the relative contributions of the business cycle and policy, and on the relative contributions of different policy actions taken.  At the same time it is clearly incorrect to attribute all of the economic improvement to the stimulus law or even to policy.

Einstein’s Insanity

Insanity:  doing the same thing over and over again and expecting different results.  (Albert Einstein)

The Department of Transportation’s “Progress report on the American Recovery and Reinvestment Act of 2009” (p. 33) shows that after one year fewer than 20% of transportation infrastructure stimulus dollars have entered the U.S. economy.  So what does Congress want to do in their next stimulus (sorry, “jobs”) bill?  Increase transportation infrastructure spending, of course.

The pending House and Senate stimulus/jobs bills are political exercises more than policy efforts.  The Reid bill is particularly laughable.  In a nearly $15 trillion economy, a $15 billion bill is a rounding error.  Its effects will be so small that no one will be able to measure it.

These bills have three problems:

1. Their effects would be small relative to the size of our economic problem.  This doesn’t mean you shouldn’t do them, just that you need to be careful you don’t lead people to believe that things will get much better if you’re successful.  You need to be careful not to overpromise.  The Administration’s track record here is poor.
2. The policies they are including are, like last year’s law, slow, wasteful, and inefficient.  Here we go again.
3. They are trying to directly stimulate job creation rather than just trying to increase economic growth.  This is hard to do.

Traditional macroeconomic stimulus focuses on increasing economic growth.  If firms expect that they will sell more stuff in the future, then they will hire people to ramp up production.  Short-term stimulative monetary policy tries to increase the purchase of stuff that is sensitive to interest rates.  Short-term stimulative fiscal policy tries to increase broadly the purchase of goods and services in the economy.  Increased job creation, should it occur, comes as firms hire workers in anticipation of greater demand for what they sell.

The pending legislation is basically trying to bypass this and instead directly change the hiring decisions of firms by temporarily reducing the costs of hiring a new worker.  They are taking the future path of economic growth as a given and trying to increase the number of workers who will be employed within that growth path.

Will private employers hire a lot more people if the costs of doing so are temporarily lowered?  I am highly skeptical.  Even in the best case, the number being bandied around by the Administration (+600K jobs over the next year) is small relative to the size of the unemployment problem.  That might knock half a percentage point off the unemployment rate.

When faced with a choice between doing something inefficient, wasteful, and directionally correct, or instead doing nothing, Congress will always choose the former.  That’s what they are doing now.  Does the Administration and Congress expect a different result from doing largely the same thing on a smaller scale?

Join the conversation about this story »

See Also:

• The Stimulus Is Obama’s PATRIOT Act
• New Bank Bailout: Just As Dumb As Bush’s
• What’s Green That’s Going To Be In The Final Stimulus