Sunday, February 09, 2014

accounting identities are not causal (and your opinion is not evidence)

Today's sermon takes the following NY Times editorial, "Will Saving on Health Care Hurt the Economy" as its text for exegesis.

And what a text it is.

Let's begin with a classic case of confusing accounting identities for causal relationships:

LOST in all the debate last week about whether or not the Affordable Care Act will hurt the economy is the fact that health care is already imposing a drag on growth.

The health care sector has repeatedly helped to pull the economy from recession in recent decades, but this time around it is lagging behind the recovery.

Health care spending grew more slowly than the economy in 2011 and 2012 and will probably be found to have done so again in 2013.

People, health care spending growing slower than overall spending does NOT mean that the sector is "imposing a drag on growth". I know people say stuff like that all the time, but it's just not true.

Nor is it true that, "the health care sector has repeatedly help to pull the economy from recession in recent decades.

Look, we can always ex-post measure spending growth by sector and compare them. But the idea that if only health care spending could be made to grow more rapidly, nothing else would change and overall economic growth would rise is risible. Those numbers are simply ex-post accounting and they PROVIDE ZERO INSIGHT into the potential outcomes of various counterfactual scenarios.

The world would be a much better place if we could just stop from abusing accounting identities in this manner.

OK. Let's take a break to pass the collection plate and then proceed to the second theme of our homily, namely that your opinion does not constitute evidence.

Thank you for your generous contributions, Now let's return to our text:

But there is evidence that moderate inflation can help to stimulate economic activity. Rising prices spur people to borrow and spend more quickly. Rising prices also tend to raise nominal wages, making it easier for borrowers to pay fixed debts like mortgage loans.

And sluggish inflation can be self-perpetuating. Inflation is rising slowly because the economy is weak, and slow inflation is restraining faster growth.

People if you click on the link purporting to give this "evidence", it's another opinion piece by the same author! And here's an example of the level of evidence being provided:

“I’ve always said that a little inflation is good,” Richard A. Galanti, Costco’s chief financial officer, said in December 2008. And then there's this gem. "Executives at Walmart, Rent-A-Center and Spartan Stores, a Michigan grocery chain, have similarly bemoaned the lack of inflation in recent months."

People, your opinion is not evidence. Empirical models with a convincing identification strategy produce evidence. Richard A. Galanti's mouth produces hot air, and, at least on this topic, Mr. Appelbaum's word processor produces gibberish.

There is a theoretical case out there that a credible promise of seemingly inappropriately high levels of future inflation can help lift an economy out of a liquidity trap. This is Krugman's "credible commitment to be irresponsible" argument. There is another theoretical case that a higher inflation target may reduce the frequency at which the economy may hit the zero lower bound on nominal interest rates.

But neither of these cases have empirical support, and even if they did, they are a far cry from the simple minded notion that, "moderate inflation can help to stimulate economic activity".


Gerardo said...

That's a three "People!" article for those of you keeping score.

Angus said...

yeah, I got pretty fired up.

John Thacker said...

There's a fine case for talking about "moderate inflation" in the sense of the total economy wide amount of money being spent-- though it's obviously even better if particular prices for particular goods decrease or stay the same, but the total amount of money increases because brand new things are invented and sold. It's nonsense on stilts to pretend that prices in one sectors growing slower than the economy as a whole proves anything positive.

Pelsmin said...

Be afraid.

I've long thought that there was one solution to our out-of-control government spending, and our government knows it well. How do you resolve $17 trillion in debt? With wild inflation, so the flat or declining economic activity generates increasing nominal tax revenues that can repay the fixed debt. That's what they mean by making it easier for borrowers to pay fixed debts.

Presidents have eschewed this simple option because of its one downside; a decline in the standard of living for all citizens.

That's historically been something the President DOESN'T want to happen. Until now. We have a President who calls for Americans to drive smaller cars, live in smaller homes, be colder in winter and hotter in summer, reduce vacation travel, etc. If that's not a reduction in the standard of living I don't know what is.

Our President would consider runaway inflation a WIN-WIN (sorry for the Ford pun -- couldn't resist.)

Unknown said...

Accounting identities and causality are indeed not the same. But the interesting thing about accounting identities is things all have to add up, at least ex post. Which some economists - even Nobel Prize winning ones - many policy makers, and many professional investors have a very hard time acknowledging, never mind applying in their own analysis and policy prescriptions.