I was interested to read recently at the Huffington Post that John Makin, an economist at the American Enterprise Institute (“AEI”), a conservative Washington, DC think tank, had recently written that the U.S. was already on a deficit reduction path and that there should not be more deficit reduction at the current time. Of course, liberals like this message coming from a conservative, but, if one reads Makin’s paper, there is much in it for liberals to dislike. The paper does not appear, though, to be aimed at convincing liberals. It is aimed at a different audience.Before turning to this recent paper, I note that Paul Krugman once praised John Makin in a post about an article Makin had written in 2010. The title of Krugman’s post was “John Makin’s Hair Is On Fire.” Krugman wrote that even though Makin is a political conservative at a “right-wing think tank,” he had written “something I or Jan Hatzius (Goldman’s chief economist — never mind the Blankfein stuff, the econ group is very good, and very pessimistic) might have written. Except Makin is even more gloomy, warning that we might enter deflation this year.”
The article to which Krugman was referring is a July 2010 Economic Outlook piece called “The Rising Threat of Deflation.” It is worth reading, and it certainly does not toe the line that austerity (“fiscal consolidation”) is a good idea. At the end of the article, Makin writes:
“The G20's shift toward rapid, global fiscal consolidation--a halving of deficits by 2013--threatens a public sector, Keynesian ‘paradox of thrift’ whereby because all governments are simultaneously tightening fiscal policy, growth is cut so much that revenues collapse and budget deficits actually rise. The underlying hope or expectation that easier money, a weaker currency, and higher exports can somehow compensate for the negative impact on growth from rapid, global fiscal consolidation cannot be realized everywhere at once. The combination of tighter fiscal policy, easy money, and a weaker currency, which can work for a small open economy, cannot work for the global economy.
“The link between volatile financial conditions and the real economy has been powerfully underscored by the events since mid-2007. Growth has suffered and subsequently recovered given powerful monetary and fiscal stimulus. And yet, the damaged financial sector, unable to supply credit; a jump in the precautionary demand for cash; and a persistent overhang of global production capacity have combined to leave deflation pressure intact. The G20's newfound embrace of fiscal stringency only adds to the extant deflation pressure.
“No wonder no country wants a strong currency anymore, as attested to by Europe's easy acceptance of a weaker euro. The acute phase of the financial crisis is over, but the chronic trend toward deflation that has followed it is not.”
One can criticize Makin’s 2010 article for being overly pessimistic; deflation has not happened. It was, though, a solid piece of analysis of the risks. Unfortunately, one cannot say the same about the analysis in his new Economic Outlook piece, “Austerity Undone” or his shorter Guardian article on the same subject.
In “Austerity Undone,” he writes that the now-famous Carmen Reinhart and Kenneth Rogoff article implying that a 90 percent debt-to-GDP ratio represents a danger point “has been shown to be seriously flawed.” He states that there are now doubts about both “fiscal austerity” and “a resumption of Federal Reserve tightening.” After all, “U.S. inflation is slowing and bond yields are falling…”
So far, so good. Makin, though, then begins to generate some confusion when he turns his attention to a recent IMF report. He writes:
“Underscoring the widespread confusion about the use of fiscal austerity, the IMF's Fiscal Monitor, after charging the United States with tightening fiscal policy too rapidly, singled it out as among the 10 countries with ‘the most severe fiscal problems,’ suggesting that it still needs to agree on medium-term deficit reduction targets.
“The IMF Fiscal Monitor prescriptions for the United States are badly muddled and ignore significant changes in its fiscal stance. The decried sequester does cut annual spending next year by about $120 billion if it is not rescinded by a nervous and confused-no thanks to the IMF-Congress. Let us hope the sequester is left in place, providing as it does a modest $1.2 trillion worth of spending cuts (only about 2.5 percent of federal spending over the next decade).”
Makin appears to be criticizing the IMF for saying that, while the U.S. has implemented too much austerity in the here and now, it is not doing enough about the deficit in the “medium term.” This view can be criticized, but Makin’s does not make entirely clear his reasons for disagreeing with the IMF. He does say that the IMF ignores the progress that has been made in cutting the budget deficit in the next few years, though Makin just assumes, with no explanation, that this is good policy. He then turns his attention to the sequester, which he claims to be a “modest” budget cut, but one which he approves. Why? He does not say, but there seems to be an implicit assumption that his audience shares his view that cutting budget spending is usually good idea, even if done in a thoughtless way. Note that he has not prepared the ground for this, because his earlier discussion said there was doubt that austerity is a good idea. He does not give a reason why “modest” austerity is then a good idea; he just assumes it. Perhaps that is a given in the lunchroom at AEI, but it is not elsewhere. And his earlier statements about austerity might not meet with AEI lunchroom approval.Another Makin opinion that may not sit well in some Republican circles is his statement that “fiscal austerity has been moderate and probably, at the current pace of deficit reduction of about $300 billion per year over the next half decade, has proceeded far enough for now.” In fact, some liberals disagree with this too, believing that the current priority should be growth and that requires increased government spending in a time of lagging private sector demand. In this paper, Makin does not provide a rationale for his position. Why is some austerity called for now, but just the current amount? The reader has no way of knowing what type of economic model Makin is relying on for his judgments.
Makin does take pain, though, to burnish his conservative credibility by criticizing the President’s budget proposal. He claims “it does not advance the fiscal debate.” Really? One may agree or disagree with the Administration’s proposals – and plenty of liberals disagree with some parts of the Administration’s budget – but to say there is no debate to be had here makes no sense. Reading on, it becomes clear what Makin really means. According to his analysis, the Administration’s budget does not reduce the deficit – in his words, advance us on “the road to sustainable fiscal policy.” In other words, the Administration does not advance the fiscal debate because Makin does not agree with what the Administration has proposed. And, he still has not explained why deficit reduction right now is more important than growth-oriented policy. Unlike some fiscal hawks, Makin is not one who argues that deficit reduction is pro-growth. He writes:
“… It is necessary to remember that placing the United States on a sustainable fiscal path after four years of trillion-dollar deficits will have consequences in the short term. Coupled with a ‘tax’ of about $90 billion from higher oil prices, the total of fiscal and oil drag prior to sequester is about $270 billion, and $45 billion in 2013 sequester raised that to $315 billion, or nearly 2 percent of GDP. That drag needs to be contrasted with average fiscal thrust of nearly 3 percentage points of GDP over 2009-12.
“The ‘fiscal swing’ of 5 percentage points of average 2009-12 fiscal thrust of 3 percent of GDP to 2013's 2 percent of GDP drag means that a sharp US slowdown may occur in mid-2013, notwithstanding the heartening signs of growth in the housing sector and a strong push from rising stock prices, all occurring while interest rates remain remarkably low. Still, Congress should not try to reverse deficit reduction progress as the president's budget has in effect suggested. Sequestration will be blamed for any slowdown, but really the cause will be a swing from steady previous stimulus to about $225 billion of fiscal drag along with some bad luck supplied by about $90 billion in higher energy costs.”
This leaves the reader still puzzling why this “fiscal drag” is a good idea, even if factors other than the sequester contribute more to the drag. Why should the government (Congress and the Administration) not pursue in a slowing economy policies generating “fiscal thrust”? Makin assumes we know the answer to that, but readers who do not instinctively share this belief are left puzzled. One wonders how Makin would articulate his position on this if challenged, which I assume is not likely to happen at AEI’s offices in Washington, DC.
Finally, when it comes to deficit reduction, it is clear that Makin prefers spending cuts to tax increases. That is a defensible ideological position, especially if one’s political philosophy leads one to the conclusion that the government’s role is currently too large. But if you are going to contend that one is preferable to the other in terms of the impact on the economy, then one should have an economic argument to back up this assertion. Here is what Makin says:
“Republicans will decry the January 2013 tax increases as crippling the economy and vow to allow no more. Democrats will decry the sequester spending cuts and vow to allow no more spending cuts without tax increases. The president has already proposed rescinding the sequester. The reality the current weak economy is demonstrating is that further tax increases to replace the deficit reduction by the sequester as proposed by the president would weaken the economy even further.”
Makin gives no reason for the contention in the last sentence. Why is that? My guess is that this paper is not really meant as an objective view of the fiscal situation and economic outlook. The evidence is that Makin is perfectly capable of good economic analysis if that is what he wanted to do. Rather, the purpose of this article is to convince Republicans that budget austerity has gone far enough for now. The political reality is that Makin has no hope in convincing them to reverse course, and he knows that. He is worried, though, that additional austerity would be devastating and is trying to convince Republicans in Congress of that while making statements that preserve his conservative credibility. He does not have to justify these statements to his intended target audience.
We are left, though, wondering what Makin actually believes. He may well believe that the current amount of austerity is correct and that increasing taxes and cutting the amount of the sequester by equal amounts is bad policy. Since he gives no reasons, we are left to wonder.
Personal Note: Early in my career I met John Makin, though I doubt he remembers me. He did some consulting work for the Treasury when I was working on U.S. balance of payment issues. He was trying to use a statistical methodology (Box-Jenkins) to predict the large statistical discrepancy that is put on the capital account side to make the capital and current account balances offset each other exactly, as they must from an accounting perspective. I also ran across him, I believe, in earlier jobs I had in international monetary research at Treasury and at the Federal Reserve Bank of San Francisco.