Jobs, Jobs, Jobs: A Followup

SYNOPSIS: A few Krugman critics have naively accused Krugman of arithmetic problems in his 4.22.03 NYT piece. Krugman debunks them.

Aha. It seems that I needed to explain something I took for granted in my piece "Jobs, jobs, jobs" in the NYT. I've gotten a fair bit of mail over the way I compared the annual cost of employing an average worker with the 10–year cost of the latest Bush tax cut. Some of the mail was in good faith, so here's the explanation.

No, I didn't forget to divide by 10. (For God's sake: whatever you think of my politics, I am a competent economist, and know how to use numbers.) What I foolishly assumed readers would know - this isn't condescension, I really was foolish - is that no serious economist thinks that a tax cut or spending increase will have any effect on employment more than a couple of years from now. The reason is straightforward: normally the economy is operating more or less at full employment, and any demand stimulus from a tax cut will be offset by an interest rate increase by the Fed. The Fed, of course, polices the economy to prevent inflationary pressures. And eventually we will return to normal circumstances.

The only situation in which a tax cut or spending increase creates jobs is when the economy is operating below full employment, and the Fed is unable to remedy the situation.

We are in such a situation right now - or at least I think we are. The Fed, by the way, does not agree: it thinks that a good recovery is just around the corner, and that it will soon be raising interest rates; in that situation any demand push from a tax cut will simply cause it to raise interest rates faster.

I don't agree, and neither do most private-sector economists; they think that the economy will remain sluggish for a while. And the Fed can't remedy the situation by cutting rates, because it has already cut them almost as far as it can. So since the economy could use a demand push right now, for the time being a fiscal expansion - either a tax cut or a spending increase - would indeed create jobs.

But this situation won't last forever. The conventional wisdom is that within a year or less the economy will be recovering nicely, and the Fed will be raising rates. So any fiscal stimulus that doesn't come in the next year will have no job creating effect; it will simply be offset by the Fed.

I'm less sanguine; I suspect that the sluggishness may persist longer. But even I don't expect a Japanese-style slump that goes on for a decade. Neither does the White House.

The bottom line is that when the Bushies talk about 1.4 million jobs, they don't mean 1.4 million jobs every year for the next decade; they mean 1.4 million jobs next year, and maybe a few the year after. Nobody, and I mean nobody, who knows any economics thinks that the tax cut will have an effect worth mentioning on employment 5 years from now, let alone 10.

And that, of course, is why the Bush tax cut gives so little bang for the buck. Almost 80 percent of the cost will come after 2004, that is, after most estimates suggest that the economy will already have recovered and won't need fiscal stimulus. By contrast, a job creation program that spent money now or in the near future would generate more jobs, at much less long-term fiscal cost.

So why didn't I explain all this in Tuesday's op-ed? Partly I fell prey to the occupational hazard of the professional economist writing for a general audience: I forgot that the ordinary intelligent citizen isn't necessarily familiar with the background material. (I'm in the same position when reading, say, about art or physics.) After 3 years writing for the Times, I usually have a good sense of what my audience doesn't know, but sometimes I forget.

The other answer is that this little explanation runs to 680 words. A whole op-ed column runs to about 730 words. You see the problem.

Update: A correspondent refers me to a nice  piece by Dwight Meredith. Let me expand on that a bit. Whatever model the CEA is using, it clearly has the property that fiscal expansion has only a temporary effect on employment: the number of jobs increases at first, then falls back to the baseline. There's a reason their model does that: it's a property of every macroeconomic model I can think of. Only someone completely ignorant of what's in the textbooks would expect the Bush tax cut to have an effect on employment that is permanent, let alone one that grows over time.

My own view is that the tax cut - or any fiscal policy - will have a positive effect on employment only as long as the economy remains close to a liquidity trap. That is, once the Fed is no longer constrained in how much it can cut interest rates, fiscal policy adds nothing to the ability of policy to achieve full employment. Now most forecasts presume that we'll be out of the trap by next year - that is, before most of the supposed job creation from the tax cut takes place. Even if you're more pessimistic than that, we're probably looking at only 1-2 years when fiscal policy creates jobs.

And the basic point remains: Bush wants a long-term tax cut, most of whose impact will come long after job creation has ceased to be an issue. Yet he sells it as a job creation policy.

Oh, one last thing: according to Dana Milbank in the Post, Bush now says that the big job estimate comes from independent economists - when in fact it comes from his own CEA, and few people outside the administration think it's realistic.

Originally published on the Official Paul Krugman Page, 4.24.03