Powerline: Economic Hacks

The right wing has continually made the argument that the 2003 tax cuts were the primary driver of the current recovery. Powerline's John Hinderacker is the latest pervayer of this myth:

The stock market is at record highs, unemployment continues at historic lows. What's not to like? Of course, one can always question the link between prosperity (or the lack thereof) and government policies. But in President Bush's case, it seems pretty obvious that his tax cuts prevented what could have been a disastrous downward spiral. At a time when our economy was subject to the double-whammy of recession and the bursting of the tech bubble, the terrorist attacks of September 11, 2001 could easily have sent the economy into a tailspin.

The problem with this statement is it gives no mention of the effects of interest rate policy on the US economy. As I will demonstrate, record low interest rates were in fact the primary driver of this economic expansion, not the 2003 tax cuts.

The chart above is from the Federal Reserve of St. Louis and it is a chart of the effective Federal Funds rate. This is one of the interest rates the Federal Reserve can directly increase or decrease at the Federal Open Market Committee meeting. Notice the Federal Reserve started to aggressively cut the effective Federal Funds rate on January 3, 2001 when they cut the rate from 6.50% to 6%. They continued to cut the rate aggressively for the remainder of the year. The rate dropped to 1.75% on December 11, 2001. There is a standard economic proposition that it takes 12-18 months for interest rate cuts to move through the economy and have their maximum impact. Under this logic, the interest rate cuts would have started to have a complete stimulative effect in the first half of 2003 which is exactly when the US economy started to grow at a decent rate.

Why is there a lag time? There are several reasons. The first is consumers like to wait and see if the drop in rates is a permanent change in Fed policy or a one time event. In order to ascertain the Fed's real policy intentions, consumers need to see more economic data which takes awhile to come out. There is also the issue of when the Fed usually cuts rates. This usually happens when the economy is already slowing or when there is a perception the economy will slow. When this happens consumers are simply more risk adverse and are less likely to take out a loan.

However, the total amount of mortgage borrowing that has occurred as a result of record low interest rates is clear from the following chart.

According to the Federal Reserve's Flow of Funds total household mortgage debt outstanding has increased from $5.325 trillion in the fourth quarter of 2001 to $10.143 trillion in the second quarter of 2007. In other words, US households have almost doubled their mortgage debt outstanding during this expansion. Econ 101 explains the reasons for this massive increase in debt: when the cost of a product is low, people buy more of it. Interest rates are the "cost of money" -- the amount it takes to borrow funds.

When you add that much money to the economy, it is bound to grow. It's that simple.

So, no John, the tax cuts had jack to do with this expansion. Record low interest rates had everything to do with the latest expansion. Anyone with a economic knowledge knows this. Of course, that would imply you have economic knowledge.

Comments

[GH]

Oh come on " this effort is ridiculous. Of course lower interest rates help. Reagan boom was blessed by falling interest rates, as was Clinton"s and Bush"s. But:

The 1990's economic boom was fueled, in part, by the shrinking savings of Americans. Indeed the personal savings rate dropped from about 10% in 1990 to 1% in 2000 (Now neg.) How"s that? Well, instead of saving money, as folks saw their 401-K's grow during the period of corporate fraud, greed and capitalism gone mad, they stopped saving and started consuming more and more. This fueled the economy. Of course when that sick and irrational bubble popped - millions of Americans lost their jobs, their health insurance and their life savings (or goodly portions of). So do we write articles saying that the Clinton years were all because folks were throwing their money away?

The tax rebates of 2001 put extra money into the economy. Bush should have given the D's the other $20 billion they had asked for (wanted $60, got $40). Likewise, stage 1of the Bush tax cut's (child credit, marriage penalty, etc) also put money right back into the economy. The larger later tax cuts also helped - but I oppose them.

Tax cuts help. Lower interest rates help, and the new world economy helped (fueled by a devaluation of the US dollar.) Real estate bubble helped.

The collapse of the Clinton bubble (read Dean Baker if you doubt) immediately threw the federal budget $100's billions into debt (perhaps the swing was $500-700 billion per year). Domestic spending increases in 2001-2003 added to this shift, the Afghanistan war in 2002, and then the Iraq War in 2003 forward (as well as Afghanistan) adds to it. Medicare Rx adds to it.

It is all of these things, and historically, it is what naturally occurs at the end of a recession.

Let's all stop trying to pin everything on one thing by being creative to the sense of being nuts. It is foolish to simply give all the credit to lower interest rates.

[flatus]

Tax cuts can only be good for the economy when that money is returned to the economy.

Squirreling the cash away in a "can I catch Bill Gates?" fund helps squat.

Yeah, yeah. Spare me the investment lecture. That's just another method of raping the worker.

[LoriAnn]

I have very little knowledge of financial matters but something tells me that an over valued stock market and artificially propped business numbers... unethical mortgages is just the tip of the ice burg...call it a hunch but I dont think this economy can continue to be tweeked here and there and continue to hold back an arterial bleed...especially with an outsourced war, the degradation of safety nets for underpriviledged citizens and the proliferation of freebees to illegals.....

[FarquadArnot]

You guys are so cute. You think that the middle class are responsible and sitting out the consumer orgy while praying for fair treatment by the rich. The middle class HAS maxed out their credit cards, leveraged their houses, cashed out their 401Ks to purchase themselves and their children cars, trinkets and junk.

This expansion was fueled by selling people shiny, unnecessary stuff. Self interest, not truth or safety, are the real motivators of our time. On some level, we all know we're in trouble but our 'make the monthly' mentality allows us to focus on today instead of the gaping maw of tomorrow.

So, in the end, it wasn't tax cuts, or lower interest or even a war time economy that made this expansion; it was good old fashion greed.

By the tortured logic of this administration, we need another terror hit to keep the economy growing.

Pull out the plastic and feel the love.

[GH]

For the record - I was suggesting that this economy ain't much difference than the economy of the late 90's. The missing element is that we did clean up corporate America (a lot of that fraud and greed and corruption) - the Enron's and the like, went out of business. But I'm just making a point. It's still a continuing of the same sort of missing bottom line good health - and the working class and the middle class, once again, will loose big time when it is over with - just as in 2000-2002.

Both economies had massive structural problems --i.e., propped up by a number of very cyclical dangerous trends.

[bowserbois]

I agree. The amerikan sheep do need another terror fix. Just like the junkies down the street.

[Kansas Evans]

I'm sorry to add the list of people disagreeing with you, but I've read that even conservative economists know the idea of tax-cuts as an economic panacea is a Laffer!

Tax-cuts from, say, 65% to 55% is good, but we've long since past the point where tax-cuts are doing anyone any good, including the ones receiving the tax cuts.

[papau]

Confuse personal with national savings much? National savings improved under Clinton and dropped under Bush 41 and Bush 43 http://www.federalreserve.gov/boardDocs/speeches/2005/20050302/figure1.gif .

For those that have forgot Econ 101, national saving (NS) are private saving in the economy (S) less budget deficits (BD), which also can be calculated as domestic investment (I), which is spending on new capital equipment, less the portion of investment financed by borrowing from abroad (B). National savings track investment (assuming we are not selling off the nation via massive increasing foreign borrowing)- not personal savings.

Meanwhile more and more of our future output will now go post Bush to pay for current out of control international borrowing, an item rather stable as a ratio to GDP under Clinton, and which is now out of control under Bush.

Since a long term move toward fixing the situation is Clinton's 1998 proposed add-on individual accounts on top of Social Security with some tax on top of the current SS payroll tax to fund those accounts, plus changing the payroll tax by removing the wage cap on the payroll tax, Bush naturally wants to screw things up by having subtractive individual accounts, while keeping the wage cap in place.

http://www.federalreserve.gov/boardDocs/speeches/2005/20050302/default.htm#fig_1

Those tax cuts did nothing but destroy this economy - they could not have been more poorly structured - unless getting less bang for the buck is the goal.

The money supply tracks the economic results with the usual lag - while the tax cuts, financed by borrowing from Social Security and abroad, were a minor stimulus, they were much more a disaster for our children's future.

[Grit]

Sorry but the Bush tax cuts have had nothing to do with any economic growth. All the tax cuts Bush did are nothing more than welfare to the richest in the nation. If you give a rich man a tax cut he will put it in some form of hedge fund. If you give tax cuts to middle class and poor they will spend it. On new tires, maybe a new car, shoes for the kids, pay off debts etc. Not to say the rich don't buy these things. its a difference of 5% of the population buying these things, and the other 95% all of a sudden being able to buy some of these things. And it wasn't a Clinton bubble that threw the budget in to debt it was Bush's tax cut and spending policy. Oh and btw better get use to saying amero not dollar.

[GH]

Grit..And it wasn't a Clinton bubble that threw the budget in to debt it was Bush's tax cut and spending policy. Oh and btw better get use to saying amero not dollar.

Excuse me.. I'm not one to blame Clinton for the bubble, but Progressive economist Dean Baker blamed him for not addressing it... but it was what it was. When the bubble collapsed (the peak of the broad market was in late 1997 - the dot.com busted in March 2000) some $8-12 Trillion dollars of equity dissolved away. And with it went hundreds of companies and millions of jobs. The reveresal led to something close to $1 trillion in debt (the dissapearance of the surplus replaced by deficit) by the time the budget was around $400 billion+ in deficit in 2003 -- All before the cost of the Iraq war and the Bush tax cuts hit the books. It was 80+% from the bust of the late 90's bubble - and added to by the economic effects of 9/11. And yes - Bush massive incrases in social services, Medicaid, Veterans, etc., also added a bit to that --- but the Democrats wanted to spend more - by the way. In case you did not notice, I was on record in not supporting most of the Bush tax cuts.

[noamjunior]

The idea that giving tax breaks to rich people helps the economy is the biggest bunch of bullshit ever sold to the American people- founded on the same twisted logic that allows cons to deny the dangers of cigarette smoke and the reality of global warming.

IF you want to help the economy it is much better to give a thousand people 100 dollars than give one person 100,000$ - common sense.

to stimulate the economy raise taxes on rich people and provide tax breaks for spending that really does stimulate the ecconomy

[tomsthumb]

Lets not forget that the dollar is worth half of what it was in 2000. The middle class is systematically being eliminated.

[SisterAnn]

One thing I noticed was, toward the end of Clinton's term, Greenspan started raising interest rates steadily. That could be a big part of the reason for the recession.

Then Greenspan rushed to lower them after Bush made it to office.

Greenspan can say what he wants now, but he was purely on the side of Republicans during his term in office.

[Dangoodbar]

"Let me write $300,000,000,000.00 of hot checks a year and I too could give you an illusion of prosperity." Lloyd Benson, 1988.

"If I could spend $1.50 for every $1.00 of income for I could live better for a time." The common man, 2001 through today.

Bush's big spending and the deficit has had more to do with the economic recovery then tax cuts and even low interest rates.

I mean if we were to max out all of their charge cards, mortgage their house to 100%+ of value, cash in their kids college funds and their retirement funds, and borrow as much as they could as fast as they could, we also for a time could live better and give an appearance of prosperity.

Of course none of us would be so reckless as to do this.

The fact is more then tax cuts, government spending helps an economy get out of recession. Furthermore, where spending goes directly into the US economy, tax cuts often go into other economies.

For example some of the biggest Bush tax cuts have been for corporations to build new factories and buy knew equipment regardless of where those factories and equipment are built.

As a result some of the largest tax cuts have actually hurt the US economy by moving jobs offshore.

This is why Bush was such a spending hawk before the 2004 election trying to find new ways to spend money like on marriage councilors and going to Mars. Bush knew it was the spending and not tax cuts that would get America out of the recession.

[jimmyf]

hi,
I think it may be better to view associations as evidence rather than proof. Because our age correlates well with commercial air line trafic, in general, this does not mean that if some one died sooner or was not born that this would have a significant and mandatory effect on passanger airline data.

[Kendo Nagasaki]

Would it not have been better if Greenspan had left the Fed funds rate at say 4% rather than move it up and down to cause these economic booms and busts?

Or is this deliberate to enable his corporate cronies to make money off the backs of ordinary folks ?

[givemycountryback]

I know a person who was charged $7000. for a life flight to a better hospital. At the point he got it , he needed it because he spent 5 days in ICU at the local meat factory, I mean hospital. They failed to diagnos him after many MRI and tests. He recovered because they did find out the problem at the "better" hospital. He now faces $150,000. in debt over all this. He is a small business owner who doesn't know what he'll do now. and that is not all his bills. And you think there isn't a health care crisis. I believe this life lift thing is turning into a scam. And doctors who can't diagnos an ingrown nail after 3 or 4 $3000. MRIs. What a joke this all is. But it is not funny.

[BuyRubles]

If something like that were to happen to me, I would get treatment in the US and skip the bill, flying to Europe.

[Grit]

Health care in this country has gotten to be a joke to the rest of the world. I was recently in hospital 8 days, the bill for just being there to my insurance company was 10k and to me 1k and thats just for being in a bed, not counting the tests. Now I am doing chemo it is costing the insurance company 8k a month and me 800 a month. And I get 1 injection of sandostatin a month it has gone from 1500 each shot to over 2800 in 3 years. Same stuff costs 900 in canada. And the US goverment paid 80% of the cost of R&D 20 years ago.

[janmB]

Obviously there are two economies going on in this country. You don't hear an unilateral response of how great things are.
If as an individual---a family---those surrounding you aren't doing so SWELL then all the statistics you hear won't mean
DIDDLYSQWAT.

[yappnmutt]

bernanke's preemptive strike on the dollar and trichet's refusal to play along means the world looks like its ready to spank uncle sam for spending all its money on candy instead of the meat and potatoes mom sent him to the store for. ouch!

[Craig]

I suspect you are right. Bernanke would like to raise rates as a pre-emptive strike on the dollar before the market does it first. The overriding risk to the economy is a dollar crisis. With our unilateral and belligerent foreign policy there may not be much sympathy or support if a dollar crisis materalizes.

[Novista]

Low unemployment can't be taken seriously, or at least the government claims.

When the construction industry has shed jobs in 12 of the last 13 months -- 20,000 in September. No need to build new new homes when old new homes haven't sold.

Even in 'have more' land, things is tough, oh yea. Miami condo auctions, like a $600,000 unit going for about half that. Building firms trying to milk a few more bucks out of a falling market that was never going to happen.

Crocodile tears!

Half the mortgage firms in the U.S. are now out of business. Where'd all those bums go for new jobs, hey?

IBM, HP, Microsoft, screaming for H1Bs even as they downsize and outsource more. How can all this be under the radar?

[Kansas Evans]

You're right that low unemployment can't be taken seriously as this administration claims. People may have jobs, but they aren't paying much and may only be part-time.

[DemandSide]

This is exactly right. It is remarkable that such a weak expansion was produced by the low interest rates, and unfortunate that the investment was in passive housing assets rather than productive plant and equipment. No real income growth for more than half the population.

The lag effect of interest rates also puts in perspective the current hysteria on whether the Fed will or won't cut. Rate cuts won't help the economy for 12-18 months. But they will bail out the financial sector tomorrow.

[swift goat pet for truth]

I thought it was the deficit spending at a rate about $500 bil a year. But, while that may have helped, I can now see that it pales besides the refinancing boom.

[ParacleteofKavorka]

I just figured that the tax cuts were a transfer of wealth to the energy companies. Didn't energy costs go up around the same time? You didn't go out a buy a TV with that tax savings, did you? Then, you had to spend $100 to fill up your SUV. No wonder we have negative savings. Apparently, low interest rates contributed to inflated real estate prices and the inevitable bust. Is this a great country or what?

[Overd0g]

Perhaps it was the dominant driver, but I still like having more of my money rather than having it stolen by the idiots in the government to waste.

[HypocrisyAlarm]

Don't kid yourself. They've still stolen your money. They've taken out huge loans in your name which you will be repaying with interest for the rest of your life!!!

[JudgeMoonbox]

There is one calculation that I'd like to see: Take the deficit for a particular year, divide it by the number of jobs lost since the previous peak or the jobs gained since the previous low (which ever is greater.) Then take the quotient and divide that by the cost to create an average job.

The point this would make is that the Dubyanomic deficits have been twice as high as they would have been if Bush had simply hired the unemployed--and that's before you adjust for the Multiplier effect--the standard Economic assumption that a dollar will be spent 3 1/2 times in a year, creating one job will bring you 3 1/2 jobs.

[calumetkid]

Go ahead and make the calculation yourself. You will have indefinite numbers adding up to an indefinite answer. Now that will surely be helpful in understanding tax cuts.

[SisterAnn]

Gas prices, plus utility bill increases and all health care cost increases more than killed our $300 tax rebate.

Yes, it would have been cheaper for the government to hire the workers.

That is important because the reason given for helping businesses is 'they create jobs'. Never mind they create many jobs that only the immigrants will do.

If you would figure up what we have spent on the war and divide it by the gallons of oil, the true cost of oil is mind numbing.