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Carlyle vs. Keynes: How Dismal Is My Science?

12:00 AM, Jun 1, 2013 • By IRWIN M. STELZER
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Thomas Carlyle had his own reasons for labeling economics the dismal science, and today’s economists seem intent on proving that the label applies in the circumstances of today’s American economy. After all, we are being treated to some really good news, especially compared with that being dished out to our European trading partners. Top of the list is the housing market. The much-followed Standard & Poor’s Case-Schiller housing price index recorded its tenth consecutive rise and the largest gain in seven years, with all 20 cities covered by the index showing significant price hikes, and the 20-city average up 10.9 percent on year-earlier levels. Sales of both new and existing homes are up, as are applications for building permits, foretelling a rise in construction activity. All of this in the face of a payroll tax increase that hit workers’ paychecks to the tune of about $700 per year on average at the beginning of this year.

Photo of Keynes in 1935

Professor Stimulus: Keynes in 1935

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Enter those economists included as practitioners of Carlyle’s “dreary, stolid, dismal” science. Hold the applause: houses prices remain 27 percent below their July 2006 peak. Alternatively, they are now unsustainably high: we are in the midst of another housing bubble. It will pop on the morning that Fed chairman Ben Bernanke wakes up and decides to accede to the wishes of his hawkish colleagues and begin pushing rates up, which have started to rise a bit after Bernanke so much as mentioned he might do the dirty deed of withdrawing support for asset prices. That could occur as early as the next meeting of the monetary policy committee on June 18, or perhaps later in the summer. Prices will plunge, investors will flee, foreclosures will rise, and we will be right back where we were when the housing bubble burst in 2006.

Back to the good news. The federal deficit in the coming fiscal year will be a mere 3.7 percent of GDP—“mere” relative to recent forecasts, and to the 10.1 percent and 7 percent it reached in 2009 and 2012, respectively. Better still, it is now projected by the Congressional Budget Office—consumers of these data be warned that the CBO track record is not unassailable—to remain between 2.4 percent and 3.8 percent of GDP over the next ten years, both levels that a growing economy can easily support.

The tax increases imposed to avoid the fiscal cliff do not seem to have forced consumers out of the malls, nor do the across-the-board spending cuts known as the sequester seem to have caused rioting in support of government workers who were forced to take an unpaid furlough day—some chose the Friday before this past holiday weekend as their unpaid furlough day, others are filing to receive unemployment  insurance for furlough days, eliminating any saving to the federal budget. Throw in a recovering economy, tax shifting to 2012 by wealthy taxpayers seeking to avoid the 2013 increases, a few one-off revenue surprises, some imaginative accounting tricks by the Treasury, and the dreaded debt ceiling, scheduled for last month, probably won’t be reached until the autumn. The plunge in the deficit has been sufficient to persuade Republicans to search for another issue to feature in the 2014 congressional campaign.

Not good enough for the proud, or perhaps prescient, wearers of Carlyle’s label. In the longer run, entitlement spending—social security, Obamacare and other health care programs—“is set to explode, placing enormous pressure on other priorities such as defense spending,” according to the Heritage Foundation, a Washington-based think tank. Even the reduced federal deficits are adding to accumulated government debt, which might well increase to growth-choking levels. But it would be unwise “to make reducing the amount of federal spending set to occur in the next few years a higher priority than helping Americans get back to work,” argues Michael Strain, a research fellow at the American Enterprise Institute. Yet, notes Strain with unconcealed dismay, this is precisely what Republicans and to a lesser extent the President are proposing to do. Strain contends that the structural changes that would prevent an explosion in entitlement spending will have dire consequences for the jobs market, which despite recent improvements is providing work for only 58.6 percent of the working age population, the lowest figure since the early 1980s, and “a human crisis as much as an economic crisis.”

Back to more good news. Consumer confidence is at its highest level in more than five years. Consumers’ appraisal of both current and future conditions are cheerier than they have been since the recession began, and the portion of those surveyed who believe that jobs are hard to get is falling (more on that next week when the latest jobs report is published). Consumers are spending not only on houses and on cars, but on household appliances and the other stuff needed to convert the purchase of a house into the purchase of a home—personal consumption expenditures jumped 3.4 percent in the first quarter. Business spending on equipment (excluding volatile aircraft orders) is also up by 1.2 percent, not great, but enough to prompt Paul Ashworth, an economist at Global Economics in Toronto, to dub the latest report on durable goods sales “another sign that growth is holding up quite well.” Overall, the economy grew at an annual rate of 2.4 percent in the first quarter, not spectacular but well ahead of the 0.4 percent in the final quarter of 2012.

But all is far from well in this almost best of all economies, or at least one that is in far better shape than in the recent past. Hear this from the dismal set. The full impact of cuts in government spending is yet to be felt, and we don’t yet know “how well the economy fights through the significant fiscal drag,” warns Bill Dudley, president of the Federal Reserve Bank of New York. Increases in stock prices are far outpacing growth in the real economy and may be headed for a midyear swoon,” suggests AEI economist John Makin. Consumer spending cannot be sustained without a real increase in incomes, which has not yet occurred writes David Wessel, economics editor of The Wall Street Journal. Consumer confidence is a volatile indicator, and consumers often say one thing to pollsters and do another. 

In 1930 John Maynard Keynes characterized the Great Depression as a “nightmare which will pass away with the morning.” Policy might be in “a colossal muddle,” but “we remain capable as before of affording for everyone a high standard of life.” No dismal scientist he, and a reasonable model for others.

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