Saturday, March 17, 2018

Kudlow Predicts An Investment Boom

Kudlow channels his inner Gerald Friedman:
Larry Kudlow, picked to be President Trump’s new economic adviser, has privately told the White House that the nation’s economy is on the verge of 4 percent to 5 percent growth, or more than double the last decade. In a recent gathering with Trump, he said that many firms held back investing until the tax reform package passed and “some of that is already showing up.” What’s more, he told the president, “We’re on the front end of the biggest investment boom in probably 30 to 40 years.” The president responded, “Well, I couldn’t have said it any better.”
OK - I get that Friedman was looking at a progressive fiscal agenda whereas Kudlow supports Starving the Beast to pay for more tax cuts for rich people. My point is that both of them take a cavalier modeling of potential GDP. And when Friedman’s supporters try to argue that potential output has been growing by 3.5% per year since 2000, I noted that his is also Kudlow’s approach:
It is sort of funny that Kudlow and Novak were making a Keynesian economics argument given both of their disdain for Keynesian economics. Of course summing 8 numbers when the right approach would be to take the average of 8 numbers is a conceptual error that one would trust a first grader could point out. It is also interesting that Kudlow wanted to assume that potential real GDP always grows at 3.5% as he is likely going to be Trump’s chief economic adviser. Trump is even bragging that Kudlow now favors tariffs. And why not – Lawrence Kudlow’s entire career has been telling any lie that his political master want him to tell as long as there is another tax cut for rich people in store.
Brad DeLong has this silly idea that we should take modeling seriously:
The rule-of-thumb is that each 1% point rise in investment as a share of national product adds 0.1% point to the annual growth rate. To get from a growth rate of 2.5% up to 4.5% would thus require a 20% point jump in the investment share of national product—if you were to get it from investment. If you were to get it from employment growth, with Okun's Law, you would need the unemployment rate to fall by 1% point per year—which means the unemployment rate would hit zero by the start of 2022. And there are no signs of a productivity growth recovery: given demography, labor productivity growth would have to consistently hit 3.75% per year in order to get to 4.5% per year real GDP growth.
When I read this, I noted over at Brad’s place:
I guess Kudlow thinks the FED will keep interest rates really low even if we soar past full employment and inflation takes off! Me thinks he learned the wrong lessons from the 1980's when the Volcker FED made sure real interest rates soared in response to the 1981 tax cuts. Of course given that it is Kudlow, he likely does not know the difference between changes in nominal interest rates v. changes in real interest rates.
So what was the quip about something that happened over 30 years ago? Oh yea – we have very strong growth over the 1983 to 1985 period – something else the Friedman supporters are fond of noting. But of course that was the recovery from the deep Reagan recession. If one looks at potential GDP growth over the 1981 to 1992 period or even actual real GDP growth over the same period, the growth rate was closer to 3% per year in large part because the Reagan fiscal stimulus crowded out investment. Menzie Chinn recently suggested:
Mr. Kudlow is apparently on the short list for new National Economic Committee chair. Maybe a good time to review some of his macro predictions.
OK – his track record on economic forecasts is dreadful. So why would this time be any different? Then again when people were filling out their brackets for March Madness the thought process was generally that no 16 seed had ever defeated a 1 seed.

13 comments:

bbk said...

Man, you really want to keep sticking it to Friedman/anyone who was persuaded by his analysis.

Is the rebuttal to Friedman essentially the fed will "take away the punchbowl" if growth is too hot? If so, that's not really an argument against Friedman's economic analysis. It's a political argument about how much power certain groups have to influence the fed/who does the federal reserve really look out for when they make monetary policy decisions.

Peter said...

Exactly right bbk.

ProGrowthLiberal said...

"If so, that's not really an argument against Friedman's economic analysis."

I think this point has been made many times but in case you missed it. Anything that tries to forecast output growth over a decade and does not even consider potential output cannot be called an economic analysis.

rosserjb@jmu.edu said...

I am not interested in revisiting the tangled discussion from last year of Friedman's poorly presented model, but the early signs are that Trump is unlikely to get the investment boom he and Kudlow have been forecasting. Dean Baker, who has praised Kudlow for having him on his show and being a good host (with even Doug Henwood also weighing in on Kudlow as not too bad to deal with personally), has been tracking signs of a possible uptick in capital investment following passage of the tax cut legislation. There are few signs of any uptick at all, much less anything that would remotely resemble a boom. There was an increase in investment last year, with over half of it in the clearly favored energy sector, with higher oil and gas prices also fueling that. But all that seems to have petered out, and there appears to be barely any increase at all going on with investment.

Whether or not this means there would have been a similar lack of an investment surge under a Bernie/Friedman regime is, I think, impossible to say.

ProGrowthLiberal said...

"Whether or not this means there would have been a similar lack of an investment surge under a Bernie/Friedman regime is, I think, impossible to say."

We do know that a President Sanders would have paid for more public infrastructure investment financed by tax increases on the rich. As such we would likely get more national savings as the rich consumed less so we could have both more public and private investment.

There was nothing wrong with the Sanders fiscal proposals. The problem was that he commissioned no credible economist to model out the actual effects. Had he done so - I suspect an appropriate analysis would have noted his fiscal policy ideas were good ones.

rosserjb@jmu.edu said...

Well, there would have been less savings by rich because he would have lowered their net incomes by higher taxes, but otherwise, probably, even if strictly hypothetical and depending on a friendly enough Congress to pass some of it.

bbk said...

ProGrowthLiberal,

I appreciate you taking the time to reply. I'm just an innumerate lawyer (the most math I do is multiplying hours worked over 40 in a workweek by 1.5 times the hourly rate to determine how much overtime a client may be owed) so I certainly defer to your experience and expertise when it comes to modeling, other sorts of technical analysis, and economic concepts like how to determine an economy's potential output.

But when you say "Anything that tries to forecast output growth over a decade and does not even consider potential output cannot be called an economic analysis", it seems like you are not looking at Friedman's analysis "standing in his shoes", so to speak, especially in light of Friedman's responses to the criticism which focused on how one should go about estimating an economy's potential output.

Since the very nature of potential output, how it's determined, and how it can be influenced by policy seems to be an important point of contention between the camps.

Friedman addresses the concept of potential output here: Gerald Friedman Responds to the Romers on the Sanders Plan: Different Models, Different Politics (https://www.nakedcapitalism.com/2016/03/gerald-friedman-responds-to-the-romers-on-the-sanders-plan-different-models-different-politics.html)

His argument appears to be that he believes potential output is more malleable over the long run via policy choices, while his detractors disagree policy can create a long term increase in the economy's capacity.

As Friedman puts it in the article:

"In this debate, there are important empirical questions dividing me and the Romers: are we 11% below capacity, as I would estimate, or are we 2-4% below, as the Romers suggest? But the larger theoretical issue goes beyond this: is capacity set, is productivity growth exogenously determined, or are these endogenous with respect to output levels? In short: does capacity rise when the economy expands?"

So when you say his non-analysis fails to "consider potential output", it seems like you are ignoring or dismissing how he does consider potential output because it does not comport with how you think economic capacity is determined and/or subject to change due to policy choices. Since the assertions about potential output/capacity in his analysis paper (using "paper" in the loosest way) don't follow the way you would make such an analysis.

ProGrowthLiberal said...

bbk - thanks for an informed response which is quite refreshing. His original paper did not consider potential output. His defenders may have but in weird ways. I will take a look at how Friedman addressed this issue since you have provided the link. Thanks.

ProGrowthLiberal said...

Oh wait - I did read this back then. First of all his suggestion that the Romers are just moderate version of the New Classical camp is just wrong. But let's go to key issue:

'In this debate, there are important empirical questions dividing me and the Romers: are we 11% below capacity, as I would estimate, or are we 2-4% below, as the Romers suggest?'

If one reads what Brad DeLong was saying then - the gap was closer to 6%. Something that strikes me as reasonable. But even if it were 11%, you cannot get even close to his original forecast without some productivity miracle. Then again JW Jason's original gap estimate was 18% which was derived Kudlow style as I noted.

bbk said...

Friedman's point is that is not the "key issue". He thinks the key issue is the second part of the paragraph. What is your opinion on:

"But the larger theoretical issue goes beyond this: is capacity set, is productivity growth exogenously determined, or are these endogenous with respect to output levels? In short: does capacity rise when the economy expands?"

I understand you disagree with his estimates of the gap between current output and potential capacity. But if you disagree with Friedman's opinion on how the economy's capacity can change then you are kind of talking past each other when you analyze the output gap under the proposed Sanders' policy regime.

Anonymous said...

"But the larger theoretical issue goes beyond this: is capacity set, is productivity growth exogenously determined, or are these endogenous with respect to output levels? In short: does capacity rise when the economy expands?"

Good.

Calgacus said...

Excellent comments bbk. The difference between Friedman and the Romers & ProGrowthLiberal are primarily theoretical, but very important. One side relies on theories which are ultimately incoherent and often fit the real world poorly, today and in history. And imho it is not Friedman's.

ProGrowthLiberal said...

"But the larger theoretical issue goes beyond this: is capacity set, is productivity growth exogenously determined, or are these endogenous with respect to output levels? In short: does capacity rise when the economy expands?"

The key here is why would a stronger economy cause potential output to grow faster. The usual explanation is that investment demand (both in terms of physical capital and hum capital) would tend to be higher under full employment than under a depressed economy. This is not a new idea as Paul Samuelson was suggesting this in his youth. The next step would be to actually model out how large these effects are. Many traditional economists have. Gerald Friedman as far as I can tell never really did. So who is being the theoretical one here again?