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NOTES ON GERALD
FRIEDMAN
J. Bradford DeLong
U.C. Berkeley, NBER, and WCEG
http://bradford-delong.com
brad.delong@gmail.com
@delong
https://www.icloud.com/pages/
0n7dprWN7e0ZqfoYxNytgBEwg
http://journals.sagepub.com/doi/pdf/
10.1177/0486613417721238
2017-12-17
3199 words
I. Introduction
Since 2010 fi scal policy austerity has been a disaster for
both Europe and the United States.
But how much better could things be? How much good
could be done by a restoration of a sensible fi scal policy?
I take a sensible fi scal policy to be one that, in the words
of Abba Lerner, recognizes the fi rst principle of
functional fi nance:
1
1
1
Abba Lerner (1943): Functional Finance and the Federal Debt,
Social
Research
http://public.econ.duke.edu/~kdh9/Courses/Graduate%20Macro
%20History/Readings-1/Lerner%20Functional%20Finance.pdf
The fi rst fi nancial responsibility of the government
(since nobody else can undertake that
responsibility) is to keep the total rate of spending
in the country on goods and services neither greater
nor less than that rate which at the current prices
would buy all the goods that it is possible to
produce….
In applying this fi rst law of Functional Finance, the
government may fi nd itself collecting more in taxes
than it is spending, or spending more than it collects
in taxes, In the former case it can keep the
difference.…
In the latter case it would have to provide the
difference by borrowing or printing money. In
neither case should the government feel that there is
anything especially good or bad about this result; it
should merely concentrate on keeping the total rate
of spending neither too small nor too great, in this
way preventing both unemployment and inflation…
I think a sensible fi scal policy
entailing
larger defi cits and
much more aggressive federal spending on investment—
and remember that improving public health and the
human capital of twelve year olds are just as good
“investments” as big pieces of useful infrastructure, and
much better than border walls—would do a lot of good.
Gerald Friedman thinks that it would do about four times
as much good in the long run as I do.
Let me try to fi gure out why:
2
II. Sanders’ Programs and Friedman’s
Assessment
On January 28, 2016, Gerald Friedman presented in
Friedman (2016a)
2
his summary and assessment of the
Sanders programs. Friedman said, starting from an initial
baseline of a $19 trillion 2016-value level of real GDP,
that Bernie Sanders proposed raising
3
:
•
federal general infrastructure investment by an average
of 1
%
of GDP for fi ve years,
•
expenditures on green energy and global warming
control by 0.5
%
of GDP for 10 years,
•
subsidies for college education by 0.3
%
of GDP for 10
years,
•
spending on health care by 6
%
of GDP for 10 years,
and
•
other spending—pensions, Social Security, paid leave,
youth jobs—by 0.6
%
of GDP for ten years.
And in 2026, the tenth year of the program, the then-
current fi scal spending stimulus would amount to 7.4
%
of
that year’s GDP.
3
2
Gerald Friedman (2016a): What Would Sanders Do? Estimating the Economic
Impact of Sanders Programs
http://www.dollarsandsense.org/What-would-
Sanders-do-013016.pdf
3
Friedman
(2016a), table 19
:
https://www.evernote.com/l/
AAHrQnOpP_NHe5la4BS6dKRNLEj2DKf8JiQB/image.png
Friedman (2016a)
then went on to set out projections of
the effects of the Sanders programs thus:
The Sanders economic policy will achieve broad-
based and sustained prosperity.... The growth rate of
the real gross domestic product will rise from 2.1
%
per annum to 5.3
%
... real GDP per capita will be
over $20,000 higher in 2026 than is projected under
the current policy.... Nearly 26 million additional
jobs in 2026.... The growth rate in output per
worker (labor productivity)... will double to over
3
%
per annum...
According to
Friedman
, it was likely that under the
Sanders programs:
•
real GDP would grow from $18.9 2016-value trillion to
$31.9 2016-value trillion—a growth rate of 5.3
%
/year.
•
employment would grow from 144 million to 185
million—a growth rate of 1.4
%
/year.
By contrast, the then-current CBO baseline projections
were that from 2016 to 2026:
•
real GDP would grow from $18.9 2016-value trillion to
$23.3 2016-value trillion—a growth rate of 2.1
%
/year.
•
employment would grow from 144 million to 159
million—a growth rate of 0.6
%
/year.
Thus an extra 3.2
%
/year of economic growth and an
extra 0.8
%
/year of employment growth over a decade
4
were likely to be produced by a sustained fi scal spending
stimulus of less than 10
%
of GDP. This seemed to me
and to others to be very optimistic indeed—an order of
magnitude larger than it was reasonable to claim.
4
II. Interpreting Friedman (2016a)
That the dependence of long-run economic growth on a
healthy macroeconomic environment is substantial is, in
my view at least, all but certain. Growth in potential
output is not exogenous to the state of the business cycle.
As John Maynard Keynes (1936)
5
wrote, full
employment boosts growth by removing the very
substantial gap between desired savings and actual
investment that has always plagued industrial economies:
Whilst… [my proposed] enlargement of the
functions of government… adjusting to one another
the propensity to consume and the inducement to
invest, would seem… to a contemporary American
fi nancier to be a terrifi c encroachment on
individualism. I defend it… as the condition of the
successful functioning of individual initiative.
5
4
As was fi rst and most powerfully argued comprehensively by Christina Romer
and David Romer (2016): Senator Sanders’s Proposed Policies and Economic
Growth
https://evaluationoffriedman.fi les.wordpress.com/2016/02/romer-and-
romer-evaluation-of-friedman1.pdf
5
John Maynard Keynes (1936):
The General Theory of Employment, Interest,
and Money
(London: Macmillan)
https://www.marxists.org/reference/
subject/economics/keynes/general-theory/ch24.htm
For if effective demand is defi cient, not only is the
public scandal of wasted [current] resources
intolerable, but the individual enterpriser… is
operating with the odds loaded against him. The
game of hazard which he plays is furnished with
many zeros, so that the players as a whole will
lose….
Hitherto the increment of the world
’
s wealth has
fallen short of the aggregate of positive individual
savings; and the difference has been made up by the
losses of those whose courage and initiative have
not been supplemented by exceptional skill or
unusual good fortune. But if effective demand is
adequate, average skill and average good fortune
will be enough.
The authoritarian state systems of today seem to
solve the problem of unemployment at the expense
of effi ciency and of freedom. It is certain that the
world will not much longer tolerate the
unemployment which, apart from brief intervals of
excitement, is associated and in my opinion,
inevitably associated with present-day capitalistic
individualism. But it may be possible by a right
analysis of the problem to cure the disease whilst
preserving effi ciency and freedom…
But the question is: how big are these effects?
Friedman
(2016a) declared that his assumed multiplier
for his analysis of the Sanders programs would average
0.89 for 2017-2026, and would be 0.87 for 2026.
6
Applying that multiplier to the 7.4
%
of GDP tenth-year
spending stimulus in Friedman’s estimate of the Sanders
programs tells us that, in Friedman's projection, demand-
side stimulus would make real GDP in 2026 higher than
otherwise by 6.4
%
of GDP—$2 trillion for the year.
Therefore of the difference between Friedman's $31.8
trillion Sanders Plan and the $23.3 trillion CBO baseline
2016-value real GDP projection:
•
$2 trillion is due to higher demand and a higher-
presume economy in 2026 than was assumed by CBO.
•
$6.5 trillion of extra 2016-value real GDP in 2026—
24.6
%
of that year’s level—is due to higher supply, a
greater potential output in 2026 than was assumed by
CBO.
I therefore conclude that the 69.1
%
percent of a year's
GDP in fi scal stimulus between 2017-2025 inclusive
would have raised the economy's short-run productive
potential by 24.6
%
. Each unit of stimulus would have
been projected to raise the permanent productive
potential of the economy by 0.36 units.
In the framework of DeLong and Summers (2012)
6
,
given that Friedman’s multiplier is a bit less than one,
that translates into an assertion of the value of the
hysteresis η coeffi cient:
7
6
J. Bradford DeLong and Lawrence H. Summers (2012): Fiscal Policy in
a Depressed Economy,
Brookings Papers on Economic Activity
2012:1
http://larrysummers.com/wp-content/uploads/
2012/10/2012_spring_BPEA_delongsummers.pdf
η = 0.4
where “η” is the symbol Larry and I chose for what we
called the “hysteresis” parameter: the boost to production
by generated by all of the kinds of extra investment in the
economic future that follows from an economy running
hotter and closer to its short-run productive potential by
one unit.
III. How Much “Hysteresis” Is There?
Back when Larry and I were in this game in 2012, we
considered a range of values around η = 0.1. The greatest
value we dared to set forward, even as an upper bound,
even for even our most optimistic projections, was η =
0.2.
An η = 0.1 meant that a fi ve-year depression would lower
potential by half of the average gap. An η = 0.1 meant
that a ten-year depression would lower potential output
by the entire average output gap. These seemed to our
judgment to be plausible magnitudes for the dependence
of the economy’s productive potential on macroeconomic
distress.
And so to me a value η = 0.4—that a mere 2.5-year
recession would lower potential output by the entire
amount of the average output gap—seemed far, far too
large to be credible. And we very much wanted our paper
to be credible to as many people as possible.
This judgment was based on two considerations:
8
The fi rst consideration started from the back-of-the-
envelope calculation that a one-unit output gap was
composed two-fi fths of a shortfall of physical investment.
Combine that with our belief that the marginal net rate of
return on physical investment was 10
%
—made up of an
equity capital return of 6
%
, a corporate tax wedge of
1-2
%
, and surplus-sharing with workers and executives
of 2-3
%
. Add on the wild guess that the other forms of
investment associated with a high pressure economy
were larger than the boost to potential from higher
private investment, but not that much larger.
9
These other forms of investment, of course, range from
more labor force attachment to denser Granovetter-style
7
weak-tie networks for job search to more on-the-job
informal and formal training to more active communities
of engineering practice to more experimentation with and
learning about business models. We no next to nothing
about how large these effects are.
Thus, at fi rst, the decision to set η = 0.1 as the central
case was merely a calculation followed by a belief and
then extended by a guess.
But the argument was strengthened by a second
consideration. Consider American economic history. It is
very diffi cult see large and permanent depression of the
rate of potential output growth following any of the
major and at times lengthy recessions of the pre-Great
Depression period. And whatever damage had been done
to long-run productive potential from the Great
Depression and its decade-long output gap appears to
have been offset by the boost to productive potential
from the extremely high-pressure economy of World War
II. Moreover, the post-World War II period appears to see
substantial return after downturns toward if not to the
previous growth path of potential output.
There is long-run variation in the post-World War II rate
of economic growth. But, at least in the standard reading,
it appears to be due to changing demography plus two
trend breaks in the rate of ongoing productivity growth:
10
7
Mark Granovetter (1973): The Strength of Weak Ties,
American Journal of
Sociology
78
:
6 (May, 1973), pp. 1360-1380
http://www.jstor.org/stable/2776392
