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Sanders’s economic plan: interesting questions remain, part 2

We continue our discussion of how big the effects might be of a large fiscal stimulus, inspired by the debate over Sanders’s plans and the realism of projected growth rates of more than 5 percent, which were called into question recently by economists Christina and David Romer. Is it dubious economics to suggest that a massive relaxation of fiscal policy might bring huge gains in employment, output, and the growth rate? We continue where we left off…

3) Romer and Romer are most puzzled by the notion that there should be permanent output gains from a stimulus plan. Aside from a mathematical gaffe of assuming that a change is actually a level, there are some hopes in this direction with a non-conventional investment function. Using a “Kalecki-Steindl” investment function, one might expect more-permanent output gains. This approach to explaining investment assumes that net investment is a function of rates of capacity utilization and the profit rate. It is as good as any for our purposes. In this model, increased demand for output brings greater investment, raising the capacity of the economy to produce. In such a model, a steady application of increased aggregate demand could bring increased “normal” capacity utilization or a larger capital stock—and hence longer-lived increases in output and growth.

Currently, capacity utilization in the U.S. is around 78 percent. The average for 1971 to present is about 80.0 percent. Rarely do capacity utilization rates in industrialized countries approach 100 percent. “Normal” levels so far below 100 percent would reflect corporate needs to maintain some excess to deter new entrants, be prepared for demand increases, and so on. Some of the “permanent output gains” derided by Romer and Romer and others might materialize if output were sustained for 10 years above this ratio. For example, raising private-sector output to 90 percent of capacity or so would eventually force firms to accumulate additional capital sufficient to bring utilization back down to desired normal rates. If companies’ desired “normal” level is around 80 percent–and firms are adding net new capacity already according to Fed data—then bringing capacity utilization down from 90 percent to normal levels would entail an increase of about 12 percent in total productive capacity. Output would then be 12 percent higher than before the fiscal expansion at any given level of capacity utilization and other variables.

To the extent the move merely increased the capacity utilization desired by firms on a “normal” basis, post-stimulus disinvestment at least might be delayed following a stimulus measure that proved to be temporary. Like the assumption of a multiplier below or barely above one, the neglect of possible long-term effects reduce the estimated impact of a possible fiscal stimulus without justification. Of course, such a vast increase in private-sector output demand would have to be phased in, rather than implemented, say, within a year

We have said that investment in our model is positively related to both capacity utilization and the profit rate. Hence, it might be argued that some increase in net investment might be offset in the investment function by a reduced profit share following Sanders’s proposed distributional measures. The formula for the profit rate would be the product of the profit share in private-sector output and capacity utilization, adjusted for taxes:

profit rate = s * u * (1 – tax rate)

More intense use of capacity (higher u) increases the rate of profit on each unit of capital invested. So higher output demand helps in this part of the investment function also. Also, a rise in the share going to labor (lower s) would increase consumption by an amount that would likely more than offset any decline in investment, at least in the short run. By assumption, we are looking at a fiscal expansion, so the tax rate in the expression above should be steady or falling.

The study by Romer and Romer does not seem to consider such effects on private-sector capacity.

4) Some argue that Sanders’s plan is simply too large and ambitious to be passed, even in the event of his election. If one prefers a more realistic stimulus, why not look at reductions in copays, premiums, deductibles etc., for current government health-care programs. The current system of government programs could, in other words, be made more affordable to the retired, the poor, and others who have enjoyed coverage but only at an increasing out-of-pocket price. One strong appeal of Sanders’s plan is the idea of eliminating such “nickel-and-dime” (actually, rather large) contributions to Medicare even as eligibility is made universal.

5) How big would a stimulus need to be? How big could it be? The discussion has opened up some debate on the topic, but likely such a stimulus plan would aim to increase growth explicitly, and to raise it somewhat gradually until goals for capacity utilization, employment, etc., had been achieved. In large part, the growth effects of stimulus are likely in Sanders’s plan to be largely offset by planned tax increases. It is an irony that concerns centered on the ability of the plan to be paid for in the manner foreseen by the campaign, when others were noting a huge proposed increase in taxes. Then the focus of the debate swung quickly to what the 4 critics of Friedman’s study found to be implausible growth numbers they found there.

6) We would imagine that if growth were proceeding too fast, leading to inflation or any other undesired side effect, before full employment were reached, one could move to a low-cost employer-of-last-resort program or the like that hired anyone desiring a job at just below the minimum wage. Another knob to adjust would be the interest rates controlled by the Fed, which are now set extremely low for savers, in part because fiscal stimulus is weak and declining.

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