Tuesday, 4 September 2012

The Grumpy Economist: CBO and fiscal cliff, again

Professor John Cochrane explains the Congressional Budget Office's (CBO) "Keynesian projections",
How does the CBO come up with these numbers? Its projections are Keynesian. If the government borrows $1 billion and spends it, the CBO will project that this action raises gross domestic product by $1.5 billion. Government workers are counted as “producing” what they cost, so borrowing money to keep them employed generates the same GDP as building a bridge. If the government just gives the money to people, this also raises the CBO’s GDP estimate. Reducing government spending and transfers has the opposite effect.
If, like me, you think that spending less money on useless projects is good for the economy, or that taking money from A and giving it to B has little overall effect, you would come to much different conclusions from the CBO’s.
Similarly, the CBO says raising tax rates hurts the economy because taxpayers will consume less, lowering “aggregate demand.” If, like me, you think that taxes hurt the economy not so much because of how much people have to pay rather than lend to the government, but because higher (marginal) rates discourage work, saving, investment, business formation and growth, then the CBO’s numbers are meaningless to you.
The central distinction between Keynesian and regular economics is the assumption that people don’t respond to incentives. In regular economics, prices and taxes first and foremost change incentives. Transfers, though important to the people who pay and get them, have much smaller effects on the overall economy. Keynesian economics and the CBO’s analysis take the opposite view: Transfers matter, incentives don’t.
As previously explained on EcPoFi, government spending should be subtracted twice from the reported GDP figure to get a better figure for actual value creation.

Click the link below for the full post from Cochrane.

The Grumpy Economist: CBO and fiscal cliff, again: I turned last week's CBO post into an Op-Ed for Bloomberg . This version is better. Last month, the Congressional Budget Office released ...

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