John Buell

Modelgate Revisited

Last winter, four former chairs of the President’s Council of Economic Advisors (CEA) attacked Sen. Bernie Sanders for providing unrealistic growth scenarios if his program were adopted. The “Sanders’’ numbers they cited were provided by an economist, Gerry Friedman, who is not connected with the Senator’s campaign. Secondly, the mode the CEA chairs used to chastise Sanders was the source of spectacularly wrong predictions some of these economists made after the 2008 financial meltdown. Finally, investment bankers used similar models to price the toxic securities at the heart of the financial meltdown. It is hard to imagine a worse case of the pot calling the kettle black. However, one constructive outcome of this controversy is a discussion of the assumptions behind and limits of economic modeling.

The CEA use statistical models based on the assumption that the past is proof of future behavior. University of Texas and former CBO economist James Galbraith summarizes their assumptions: “CBO [Congressional Budget Office] did not expect the recession to be any worse than that of 1981-1982, our then-deepest postwar recession. Second, CBO expected a strong turnaround beginning late in 2009, with the economy returning fully to the pre-crisis growth track by around 2015, even if Congress had taken no action at all. Why did Congress’s budget experts reach this conclusion? On the depth and duration of the slump, CBO’s model was based on the postwar experience, which is also the run of continuous statistical history available to those who program computer models. But a computer model based on experience cannot predict outcomes more serious than anything already seen. CBO – and every other modeler using this approach – was stuck in the gilded cage of statistical history. Two quarters of GDP loss at annual rates of 8.9 and 5.3 percent were beyond the pale of that history. A long, slow recovery thereafter – a failure to recover in any full sense of that word – was even more so.”

The conclusions I draw from the failure of this standard model is to question the assumptions on which it is built. These include the assumption that all market economies have a natural non accelerating rate of unemployment, that they move rapidly toward a full employment equilibrium at a pace that can be extrapolated from previous behavior.

Friedman challenges these assumptions. The difference between him and his CEA critics is not a matter of optimism vs pessimism but rather a question of fundamentally different models. Friedman’s dynamic model grows out of an economics inspired by John Maynard Keynes. Keynes rejected “the very idea that capacity output is fixed without regard to the past level of employment and production: faster growth promotes faster growth by encouraging investment, greater labor force participation, and more technological innovation with higher productivity growth.” The feedback mechanisms in such models can envisage explosive growth but also economic collapse and extended periods of stagnation. Using such models economists can make short and medium term predictions about the effects of particular policy choices.

Thus liberal economists argue that tax cuts during a recession have a lower “multiplier effect” than infrastructure spending because citizens are less willing to spend when their jobs seem insecure. Such a generalization could serve as the basis of short- term policy choices, but with the caveat that unexpected events, technological changes, and reining consumer and political sentiment could have a major effect on the multiplier. Policy makers should be attuned to these possibilities and be prepared to make adjustments.

One great strength of models like Friedman’s is the recognition of the role of feedback mechanisms. Small changes in initial conditions and/or the size of the multiplier can make a big difference in results even two or three years out.

One further factor enhancing unpredictability is the reflexive nature of economic models and forecasts. An economic model, unlike a weather forecast, plays a role in shaping the very phenomena it seeks to describe and predict. Dynamic models build in the possibility of system collapse, specify some of the conditions making that more likely, and delineate the range of possible outcomes. (University of Kingston economist Steve Keen is developing one such model that builds in the role of debt and financial volatility.) Unfortunately their work has been largely scorned even by such leading liberal voices as Paul Krugman.

In the recent US financial crisis no such death spiral occurred, but our elaborate 10-year models and predictions were not our saving grace. Just as geologists have pretty much stopped trying to predict exactly when the next earthquake will hit and advocate instead earthquake sound building codes, economic policy makers schooled by the Great Depression erected firewalls between markets that would at least dampen the positive feedback loops that made 1929 so traumatic.

Galbraith asks: “Why, in the wake of financial calamity, did the US economy fall as little as it actually did? Employment and market incomes fell by some 10 percent. Yet the fall in real GDP … from 2007 to 2009 was just three and a half percent; that in personal consumption expenditures was only two and a half percent…. The answer is that total federal government spending … rose by over six percentage points in the same period, health security payments rose 25 percent, Medicare nearly 15percent, Social Security by over 16 percent, and other income security programs (notably, unemployment insurance) by over 45 percent. Meanwhile total tax receipts fell over eight percent.” {M}ost of these changes were automatic – which is to say, they too were forecast-free.…”

These firewalls prevented catastrophe, but such walls need periodic maintenance to arrest deterioration and modernizing to address new dangers. Partisan politics plus faith in models that assured us of a return to stable prosperity prevented more vigorous action to supplement these automatic stabilizers. This leads Galbraith to suggest: “The only way to have avoided being trapped by this logic, would have been to throw out the forecasters and their forecasts. The President might have declared the situation to be so serious, and so uncertain, as to require measures that were open-ended; that were driven by the demand for them; measures that would not be subject to appropriations limits and that would therefore break, as necessary, all budgetary rules and all the constraints. A program enacted under that stipulation could then have been scaled back, once in place, should it prove to provide more support than the economy required. In early 2009, that would have been a remote risk.”

Today we have a climate emergency, with global climate change already wreaking havoc on many. That emergency is recognized at least by some. One of its enablers, however, is not as obvious. Faith that markets move toward smooth equilibriums and that nature can be controlled resonate with and reinforce each other. In particular, budgetary fundamentalism blocks the kind and amount of spending that might mitigate or slow the climate emergency. The instability of finance and commodity markets blocks planning and steady progress toward ecological alternatives.

What is needed is the emergence of a new coalitions and parallel agendas. A full employment program aimed at ecologically sustainable housing, transportation, and energy might draw more into the labor market, foster stronger intergenerational coalitions, enable a fully employed labor market to advance demands for more humane and thus productive workplaces. Each of these trends could strengthen the others. Let’s not allow old and discredited models and the market fundamentalism that underlies them stand in the way of such an agenda.

John Buell lives in Southwest Harbor, Maine and writes on labor and environmental issues. His books include Politics, Religion, and Culture in an Anxious Age (Palgrave MacMillan, 2011). Email Jbuell@acadia.net.

From The Progressive Populist, June 1, 2016

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