I’ve Got a Lot of Problems with You People

by Paul Kasriel, The Econtrarian

Paring Unemployment Insurance Benefits / Food Stamps Is Bad for the Economy

I often hear this from some of the cable news hosts and their guests. You see, according to these “economic theorists”, when the unemployed and/or lower-income populace receive various types of funds from the government, they spend these funds, thus increasing nominal aggregate spending in the economy. What could be wrong with that in an economy that is operating below its potential? Although I am all in favor of stimulating aggregate demand if it is demonstrably below potential aggregate supply, it is not entirely clear to me how increasing government transfer payments will accomplish this. The fundamental question I would ask those who make the claim that it is so is from where does the government get the funds to make these transfers?

If the funds are obtained by cutting other government expenditures, then some entities’ spending will be decreased by the amount that the recipients of the transfers spending increases. The result is no net increase in nominal aggregate spending.

If the funds are obtained by raising some entities’ taxes, then the spending of those paying the increased taxes will decrease, offsetting the increased spending of the recipients of the transfer payments. But, good Keynesians that the cable news economic theorists are, will say that those subject to the higher taxes (the RICH?) will not cut their spending fully by the increase in their tax bill, but rather will meet some of their increased tax bill by cutting back on their saving. And that won’t imply a cut back in some other entities’ spending? One man’s saving is another man’s borrowing. And most entities borrow in order to spend. If the taxpayer cuts back on his saving, this means that he is cutting back on his lending. And if he cuts back on his lending, then this means that a potential borrower/spender will remain just that, potential rather than actual. Only if the taxpayer chooses to run down his cash balances to pay some or all of his increased taxes will his or his borrower’s spending not decrease. More on this run down in cash balances will be discussed below.

If the funds are obtained through increased government borrowing, then the purchasers of this increased supply of government bonds will be curtailing their lending to other borrowers/spenders or will curtail their own spending in order to purchase the government bonds. Either way, someone else’s spending will decrease in order to fund the increased spending by the recipients of government transfer payments. The result is no net increase in nominal aggregate spending.

Now, it might be argued that the purchasers of the increased supply of government bonds used “idle” cash to pay for them. That is, it could be argued that the velocity of money increased in order to fund the government transfer payments. Perhaps. But can you be sure of this? With the elimination of Reg Q decades ago, bank deposit rates now tend to move up and down with open-market interest rates. So the interest sensitivity of the demand for deposits is not what it used to be because the interest differential is now more stable. MV ≡ PT. If PT, nominal transactions (the Price level times real Transactions), are to increase and M, the money supply, stays constant, you have to explain why V, velocity, increases.

Under another special circumstance (other than an increase in velocity of money) transfer payments can result in a net increase in nominal aggregate spending. That circumstance is when the increase in transfer payments is funded by a corresponding increase in the sum of Fed and depository institution credit, i.e., total thin-air credit. In this case, the recipients of the transfer payments will increase their spending and, by virtue of the fact that the funding of these payments is created, figuratively, out of thin air, no other entity need cut back on her/his current spending.

Why do you think unemployment insurance benefits and food stamps are called transfer payments? Because these government spending programs transfer income from certain segments of the population to other segments. If income is being transferred, it’s a good bet that spending also is being transferred. The nomenclature is a tip off that transfer payments do not, except under special circumstances, result in a net increase in nominal aggregate spending in the economy. Rather, transfer payments tend to redistribute a given amount of income and spending. The above is not meant to be an argument against transfer payments. I believe that the arguments for or against transfer payments are largely moral and philosophical. My only problem with you people arguing in favor of transfer payments is when you try to justify it in terms of macroeconomics.

Congress Should not Oppose an Increase in the Minimum Wage as It Would not Involve an Increase in Government Spending or an Increase in Taxes

I heard this one on cable news, too. As far as it goes, it is true. But, in my opinion, it does not go far enough. As I tried to illustrate in the comments above, the government has to obtain the funds it spends from some source – the nonbank public through taxes or borrowing or from the Fed and depository institutions. You might think of the government as an intermediary in the collection and distribution of funds. But just as the funding from an increase in government transfer payments has to come from somewhere, so, too, does the funding from an increase in the minimum wage. Who will get the bill for McDonald’s increased wage bill? McDonald’s customers through increased menu-item prices? McDonald’s stockholders through decreased profits. McDonald’s suppliers through decreased orders for merchandise from them. So, no, an increase in the minimum wage would not directly involve an increase in government spending or an increase in taxes. But it would involve a redistribution in income and spending away from McDonald’s customers, away from McDonald’s stockholders, away from the stockholders and employees of McDonald’s suppliers and toward McDonald’s employees. So, just as transfer payments redistribute spending and income, so does an increase in the minimum wage.

I have also heard cable news economic theorists argue that an increase in the minimum wage would result in a net increase in nominal aggregate spending. Really? Explain to me how M goes up and/or V goes up in MV ≡ PT as a result of an increase in the minimum wage. Or does P go up and T goes down? If, in fact, an increase in the minimum wage were to result in a net increase in nominal aggregate spending, then we could eliminate any shortfall in aggregate demand relative to aggregate supply by merely boosting the minimum wage to whatever level necessary to eliminate the gap. If only.

Let’s assume that the argument for an increase in the minimum wage is a moral one, not an economic one. Let’s further assume that we as a society believe that people who work are entitled to some minimum income. If their wages do not yield this minimum income, then we as a society feel honor bound to, one way or another, boost their income to the minimum. If so, as a matter of equity, why should the customers of McDonald’s, the stockholders of McDonald’s and the suppliers to McDonald’s bear the biggest burden in boosting McDonald’s employees’ income to the minimum via an increase in the minimum wage? If we as a society believe that McDonald’s employees are entitled to a minimum income, then should not we as a society be willing to have our taxes increased in order to “top off” McDonald’s employees’ market-based wages either through a wage subsidy or an increase in the earned-income tax credit?

I don’t even want to get into the economic argument as to whether an increase in the minimum wage results in someone’s loss of employment. To paraphrase an old joke, if you ask an econometrician what is the effect of an increase in the minimum wage on employment, he will answer, “What do you want it to be?”

On the Wednesday Preceding Employment Friday, It Was Reported that Private Employment Increased by X Thousand

This is not what I hear on cable “current events” news channels but on the cable financial news channels, whose producers should know better. On the Wednesday preceding Employment Friday, ADP/Moody’s releases its estimate of what it perceives the BLS is going to report as the change in private nonfarm payrolls for the prior month. The media might mention parenthetically, if at all, that this is an estimate of an estimate. Although the median absolute difference between the revised ADP/Moody’s estimate and the revised BLS estimate is only 44,000 between April 2001 and October 2013, there were 22 occasions in this timespan in which the monthly absolute difference between the two revised series was 100,000 or more. If the ADP/Moody’s estimate is that nonfarm private employment increased by 100,000 in a given month and two days later the BLS estimate is of a 200,000 increase, which estimate do you think will have the largest impact on the financial markets? If you answered as I, the BLS estimate, why does anyone care what about the estimate by ADP/Moody’s?

The (Fill in the Blank) Economic Report Showed a Change Greater than / Less than What Economists Expected

Ask an economist for a number and he will give you a number. To illustrate, some economists actually provide estimates of the ADP/Moody’s monthly employment report. Why? Because someone from the media asked. But if the media wanted to serve a useful function, they would ask two follow-up questions when requesting a forecast from an economist. How has that economist’s past estimates of a particular economic statistic compared with the actual reported statistics? And, how did the economist arrive at his estimate? That is, what’s his model – explicit or implicit? If these follow-up questions were asked and answers obtained, I wonder if anyone would really care what economists “expected”.

Then there’s the post-release interview. Economist A’s forecast of the number was plus 100,000, but the actual number turned out to be minus 100,000. In the post-release interview, in which Economist A’s errant forecast is rarely mentioned, Economist A with great confidence can fully explain after the fact why the number turned out to be plus 100,000 and will tell you that next month’s number also will likely be near the same magnitude (it’s the chameleon method of forecasting) without missing a beat or exhibiting a hint of shame. Along the same lines, economists shy away from giving a definitive forecast of a binary event. Rather, they like to hedge their forecast “bets” by giving a probability of a binary outcome. For example, Economist B thought that there was a 50% probability that the Fed would announce a December tapering in the amount of securities it purchases. Either the Fed will or will not make such an announcement on any meeting day.  It is not going to make a 25% announcement, a 50% announcement or a 75% announcement. It’s all or nothing!