Crash Course Episode #8, Fiscal Policy and Stimulus, Part 2

And we’re back for part two!  In this post we’re going to talk about the finer points in episode #8, namely what economists think of “Austerity” and “The Multiplier Effect”

Austerity

Crash Course explains Europe’s response to the 2008 financial crisis as such:

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[European countries] were pursuing a policy called Austerity: raising taxes and cutting government spending to reduce debt.

While in the US, Keynesian recessionary policy called for increasing spending and increasing their deficit (and debt), countries in Europe were focusing on reducing their deficits (and debt).

Important distinction: A country’s deficit is the difference between what a government spends and the amount of revenue it takes in.  A deficit means that the country has spent more than it has a collected, resulting in more debt at the end of the fiscal year.  In other words, a deficit is the yearly rate of increasing debt.

Side note: When people talk about Austerity, they are usually referring more to the reduction in government spending and less about increasing taxes, while both are technically austere.

Crash Course does not stray from the common opinion that Austerity is bad for an economy:

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Since 2011, when the US and European policies really started to diverge, the US economy has grown at an average rate of 2.5%, while the Eurozone GDP actually shrank by %1.  US unemployment fell to 5.5%, while Eurozone unemployment rose to 12%.

Just the facts here, all of which are true.  From here, Crash Course moves on to talk about another subject, which leaves the viewer thinking “well, with these numbers, austerity clearly doesn’t work and Keynesianism does.”

What needs to be mentioned is what European Austerity really entailed.  How much did governments reduce their spending, and how much debt did they reduce?  Below is a chart of European countries and their deficits (not debt) as a percentage of GDP:

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European countries continued to spend more than they took in, resulting in more debt (also known as taxes on future economies) each year.  While many countries decreased their deficits, they still continued to increase their debt.  Is this really Austerity?

If you compare the resulting budgets (spending and revenue) of the US and Europe following the financial crisis, they don’t look like opposites.  Europe is Keynesianism Light, while the US is like Keynesianism Extra.

As I mentioned in the last post, increasing government spending, financed through debt, will benefit the economy in the short-term at the sacrifice of future economies.  And free market economists would argue that since you are taking from the private sector and spending in the public sector, that action will necessarily make the economy worse off.

Since both Europe and the United States are spending now what they will need to tax later, it makes sense that the present economy of the bigger spender (the US) would be doing better in the short-term.  But to take selected facts and declare “increased government spending = prosperity” would not be showing the full picture.

Multiplier Effect

The multiplier effect theory is often attributed to Keynes (among others), and Crash Course explains how the theory goes:

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The idea here is that if the government spends $100, then the highway construction worker who got the money will save $50 and spend $50 on a concert or something.  The musician who got that money will save $25 and spend the other $25 and so on.  So because of this ripple effect, the initial increase in government spending of $100 might turn out to $175 worth of actual spending in the economy…

Spending on welfare and unemployment seem to give us the most bang for our buck, since people with low incomes spend virtually all of their additional income.

Basically, spending money on the poorest individuals results in a better economy because poor people are more likely to spend that money than save.  Spending is good for the economy, and saving is bad.

I mentioned this before, but money that you put in the bank doesn’t just sit there.  Banks lend out that money to the people who want it and are willing to pay interest on their loan.  Crash Course rests a lot of their economic arguments on the assumption that saving doesn’t improve the economy.  In reality, saving, instead of spending, merely shifts money toward capital goods instead of consumer goods.  The money gets used either way.

The multiplier effect also rests on another principle:

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General cuts to payroll and income taxes seem to have a multiplier of about 1; if the government cuts $100 in taxes, the economy is going to grow by about $100 […] Tax cuts  puts money into people’s hands quickly, but that money might get saved rather than spent.

I don’t know if this is true or not, and Crash Course did not explain why someone’s tax savings (or more like, many people’s marginal tax savings) is not likely to be spent, while money toward a salary would be.

Regardless of whether this is true or not, the money would be used whether government takes it from people, or someone puts in the bank and it’s lent out.

Crash Course’s Greatest Moment Yet

Crash Course concludes this episode with a fantastic point:

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When people are miserable and unemployed, they want to feel like help is on the way.  Doing nothing doesn’t create the kind of confidence that will get consumers and businesses spending again.  And it doesn’t get politicians reelected.  So it looks like Keynesian policies are here to stay.

For now, I’m going to ignore the claim that recessions are corrected by consumers and businesses “having confidence in spending more.”

The most refreshing part is the reluctant acceptance that, whether or not Keynesian economic policy is correct or not, it is going to be implemented because it gets politicians reelected, and it makes people feel like help is on the way.  Nevermind what is effective economic policy, what’s important is that it you believe it’s effective.  And why wouldn’t you?  Policians (and to some extent, Crash Course) tell you it’s effective!

 

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Crash Course Episode #8, Fiscal Policy and Stimulus, Part 1

Crash Course’s most recent video on Fiscal Policy and Stimulus has its ups and downs.  The show’s hosts acknowledge the controversy surrounding Keynesian economics, but not before treating the ideas favorably.  The show equates free market economics with antiquated (and wrong) medical science, and presents only two (both government-centered) economic policies as the potential solutions to national recessions.  Let’s start from the beginning:

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Recessions vs. Unemployment

Crash Course spends the first few minutes of the video talking about what it means when a country is in a recession, followed by a brief history of recessions in post-WWII United States.

The episode notes that dips in the economy correspond with rising unemployment, and unemployment is linked to a number of other negative societal factors: namely suicide, domestic violence, and social upheaval.

Fortunately, Crash Course also mentions that unemployment is not the only potential monster to the economy.  The show gives equal time to discussing the problems with inflation:

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High inflation can be just as bad.  Rising costs wipe out savings and have been the root of protests and riots around the world…

…Many economists argue that policymakers should intervene in the macroeconomy in order to promote full-employment or reduce inflation.

Without directly saying so (at least not yet), the show implies that large-scale unemployment and inflation happen naturally, and government policy may be necessary to fix these problems.

As I wrote about in last week’s episode on inflation, inflation doesn’t just happen naturally in the market.  Widespread price increases happen from new money being created and flowing through the economy.  When Crash Course says “many economists argue that policymakers should intervene in the macroeconomy,” they should also clarify that government monetary intervention has already occurred, and now people are considering if fiscal economic intervention is necessary.

 

To give them credit however, they are correct that unemployment would still occur in a free market.  All schools of economic thought would agree that as industries are constantly growing and shrinking, and people get laid off when their industry shrinks.  The real question between schools of thought is how a very high unemployment rate occurs, and whether government intervention prevents this from occurring (or causes it to occur).

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Expansionary/Contractionary Policy

Before mentioning that what they are about to explain is debated between schools of economic thought, Crash Course explains Keynesian fiscal policy as generally agreed upon by economists.  They later use examples from the 2008 recession to illustrate how this method of thinking is practiced in the United States, explaining away common objections to their example:

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In 2009 the US government launched a huge stimulus program in response to the financial crisis.  Despite that, employment and GDP both fell.  That sounds like a failure, but the majority of economists think that the situation would have been far far worse without that stimulus.

I mentioned this in a previous post, but if a scientist declares his hypothesis to be true, and then despite their own contrary experimental results, still declares his hypothesis to be true, there’s no use trying to convince him.  They will declare themselves the winner regardless.

Keynesian fiscal theory is based on two main assumptions: decreasing taxes and increasing government spending help the economy (and the reverse hurts the economy).  Their own admitted problem is that helping the economy in this way requires the government to increase their debt, which will be paid back in better economic times.

Taxes hurt the economy.  This is agreed upon by all economic schools of thought, even the communists.  When you take away wealth from a people, what is left is worse off than before.

Government spending helps the economy. Freemarketeers may disagree with me here, but hear me out: government spending, per se, generally helps the economy.  The problem is that government spending necessitates taxes in one form or another.  Free market theory argues that money is better spent in the market than by governments, not that government spending (again, per se), doesn’t do anything good for anyone.

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The problem is, you can’t have government spending without taxes, and while Keynesian expansionary policy may seem like you can have your cake and eat it too, issuing debt in the present is the same as taxing the future.  Keynesian economic policy taxes the future for government spending and lower taxes in the present.

Since the increase in present government spending has to come from somewhere, this policy shifts spending from the future market to the current government.  Since freemarketeers argue that any shift from the market (present or future) to government necessarily makes the economy worse off, freemarketeers oppose Keynesian fiscal policy.

So what’s up with the video’s comments on Austerity and the Multiplier Effect?  Stay tuned for Part 2.

 

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Crash Course Economics #7, Inflation and Bubbles

Crash Course’s episode this week deals with inflation and bubbles, and while they do a solid job on explaining how the CPI is calculated and the difference between nominal and real numbers, their explanation of the definition of inflation and causes of inflation were either misrepresented or not fully explained.  Let’s start from the top:

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What is Inflation?

The first thing I noticed about this video is that they never really define what inflation is.  Instead they start with the question “Why should we care?” and then explain how a reduction in your purchasing power limits the amount of stuff you can buy, so you should care.

This is probably the best time to note that there is a difference of opinion on what the definition of inflation is, and this debate is particularly between the Austrian School and everyone else.  The Austrian School of economics defines inflation as an increase in the money supply (often referred to as “printing money”), while price inflation is when the prices of goods rise.  Austrians get kind of nit-picky when people refer to inflation as an increase in the price of goods, as Crash Course does here, so I felt I needed to mention it.

As a personal view, I think a lot of time is wasted in debate talking about what the definition should be, so if people want to call the increase in prices inflation, I’m okay with it as long as we both use the term the same way.  The more important conversation is what causes [price] inflation, why, and is it a good thing?

After explaining how inflation is calculated, the video identifies that there are really two types of inflation:

Demand Pull Inflation

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They define this as “too much money chasing too few goods.”

Crash Course’s explains Demand Pull Inflation by saying:

If people have a lot of money, and they want to buy more stuff, they are going to bid up the prices for things, causing [demand pull] inflation.

This explanation of inflation is generally agreed upon between schools of economic thought, but it doesn’t fully explain what makes people have a lot of money.

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Sometimes, but rarely, a whole town strikes it rich (which is more or less what is depicted in the Crash Course video).  For example, some towns in North Dakota are now seeing prices rise because an oil field was discovered under the town, creating thousands of high-paying jobs.  Since more people have more money to spend, prices in the town increase.  But this rare scenario is not what most people consider to be inflation.

Inflation is generally thought of as prices increasing across the country, which means that both my local pizza shop and Amazon.com have increased their prices.  This kind of inflation is caused by an expansion in the money supply, meaning that new US currency has been printed and is circulating throughout the country, bidding up the prices of all goods.  Those who benefit most from inflation are the ones who get to touch the newly-printed money first before prices have risen (which are, generally speaking, investment banks), and those who suffer the most from inflation are those who touch the money last, as they usually get their wages increased only after prices have risen.

While Crash Course wasn’t wrong in their explanation, they did leave out the very important point of the origins of inflation, which they will hopefully cover in a future video.

Cost Push Inflation

Crash Course also includes a second type of inflation, which is referred to as Cost Push Inflation:

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Another cause of inflation is the decrease in availability of an important productive resource, like oil or something.  An oil shortage would increase the price of gasoline, increasing the cost of delivering flour, cheese, and pepperoni.  This would increase the cost of producing pizza, therefore decreasing the number of pizzas that can be produced.  Economists call this a supply shock and it causes something called cost push inflation.

Cost Push Inflation is actually a controversial subject between schools of economics, and Wikipedia even includes a section on its criticism.

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The problem that some schools of economic thought have with this idea is that Cost Push Inflation essentially expands the definition of inflation beyond monetary policy.  Since inflation is generally associated with interest rates, the money supply, and purchasing power, the term Cost Push Inflation conflates monetary policy and simple microeconomics.

The critics of the term Cost Push Inflation argue that natural disasters and other events that affect the price of goods should not be considered inflationary, since inflation is a term for monetary policy and affects consumers’ purchasing power, not just the price.

In other words, calling supply shortages “inflation” confuses the term.  Inflation is something that is willfully created by controllers of the money supply (usually the Fed lowering interest rates or the practice of Quantitative Easing), as opposed to something that is caused by nature (Crash Course cites disease and drought as a potential cause of Cost Push Inflation).

Crash Course’s Definition versus Others’

Crash Course sums it up this way:

To keep it simple, inflation is caused by consumers bidding up the price of stuff or producers raising prices and producing less because there’s an increase in production cost.

As I mentioned before, this is a controversial definition of inflation between economic schools of thought, but let’s look at the most cited definitions of inflation. Let’s look at the top three google results for the definition of inflation:

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From Google’s dictionary: “A general increase in prices and fall in the purchasing value of money

From Investopedia: “Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling.”

From Dictionary.com: “a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in theloss of value of currency.”

I would understand if Crash Course were following the most widely-used definition of inflation, or stated that there is debate over the proper definition, but instead they chose a definition from a particular school of thought and stated it as fact.

 

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Does Economics Not Apply to Whole Foods?

It’s been a while since the last Crash Course video, and since I can admit that I have no idea what their release schedule looks like, our wait until the next video could be a few hours or a couple weeks.  In the meantime, I’ll try to keep posting about smaller points made in the videos or the progress of the site in general.

Way back in video #4 (Supply and Demand), Adriene was talking about the price of strawberries:

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The price of strawberries isn’t always $3; sometimes it goes up to $6, and at Whole Foods, local, artisanally grown strawberries, the fancy fancy strawberries, can cost upwards of $12.  But I guess Whole Foods is a whole other world where price has nothing to do with realistic economics.

I imagine that Adriene meant to say that the demand for goods at Whole Foods is generally inelastic, meaning that a small increase in the price won’t drive away that many customers.  People who shop at Whole Foods (since it’s a premium-priced grocery store) aren’t as sensitive to price increases as people who, for example, shop at Wal-Mart or Costco.  At Wal-Mart or Costco, price very much affects customer decisions, and if you increase the price of strawberries at these places, you are likely to drive away a lot more customers (in this case, the demand would be elastic).

In fact, Whole Foods is aware of this phenomenon, as in some cases, they charge more for the same good that you could find at your normal grocery store.  Still, realistic economics still do apply to Whole Foods, and there is a price point where Whole Foods will drive away too many customers to be profitable.

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A distinction that needs to be drawn is that the strawberries at Whole Foods are not the same goods as the strawberries that you find at Wal-Mart.  Fancy, organic Whole Foods strawberries cannot be put on the same graph as normal, widely-distributed strawberries because they are not interchangeable; much more cost goes into producing the Whole Foods strawberries.  People generally value the Whole Foods strawberries more than they do the other strawberries.

Conversely, a box of Froot Loops at Whole Foods is identical to the box of Froot Loops at Wal-Mart because they are produced identically, and one could not tell the difference between the two.

Economics applies to all goods and services, fancy goods included.