"Five Macroeconomic Myths"

This being New Year's day, and a slow last few business days, I want to discuss a "filler" topic which I've hung onto since mid-December.

In the December 11th Wall Street Journal, Edward C. Prescott, 2004 Nobel Prize-winner for economics, senior monetary advisor at the Minneapolis Fed, and professor of economics at University of Arizona Cary School of Business, wrote a piece thusly entitled.

The first thing I'd like to note is that I don't think I had heard of Mr. Prescott, or could identify him in unaided recall, prior to reading this incredibly lucid and important piece. I see a constant parade of lesser economic lights troop through the CNBC studios each day, but not Mr. Prescott. As I wrote in this post, here, on June 11th of last year, there are a lot of economists who think they know more than, or as much as, Ben Bernanke. I begged to differ. However, Mr. Prescott is precisely the sort of economist to which I referred when I noted that the Fed staffs would probably be a better source of economic thought than some 'chief economist' of a second-rate US bank or brokerage firm.

Having established Mr. Prescott's credentials, let me summarize his five 'myths:'

1. Monetary policy causes booms and busts.
2. GDP growth was extraordinary in the 1990s.
3. Americans don't save.
4. The U.S. government debt is big.
5. Government debt is a burden on our grandchildren.

Suffice to say, Mr. Prescott provides some very illuminating evidence to eviscerate all of these myths.

My favorites are numbers 3-5. First, he assails national income accounting, writing,

"Our traditional measures of savings and investment, the national accounts, do not include savings associated with tangible investments made by businesses and funded by retained earning, government investments (like roads and schools) and business intangible investments."

He focuses on the relationship of wealth to income, and judges the US savings rate to be "the right amount."

Mr. Prescott observes that "privately held interest-bearing debt relative to income" is at levels comparable to those of the 1960s. So he also judges our governmental debt level to not be "too big."

Perhaps the most interesting myth is the fifth one. It's a sort of product of the third and fourth myths, with a little emotional zing tossed in about the next generation's inherited liabilities.

Here, Mr. Prescott refers to some prior research, stating,

"Theory and practice tell us that the optimal amount of public debt that maximizes the welfare of new generations of entrants into the workforce is two times gross national income, or GDP. This assumes 1% population growth, 2% productivity growth, 4% real after-tax return on investments, and that people work to age 63 and live to age 85. Currently, privately held public debt is about .3 times GDP, and if we include our Social Security obligations, it is 1.6 times GDP. In either case, we could argue that we have too little debt."

Mr. Prescott actually make the point, subsequently, that government debt is a necessity if one has a long-lived population that is not growing rapidly. In effect, the more older, non-working people a society has, the more productive assets it needs with which to generate wealth in order to pay for those retired people. It's the reverse of how most economists present this situation.

Rather than hand-wring about debt and retirement, Mr. Prescott implicitly assumes a preference for creating wealth, then assess whether the right debt levels are in place to most efficiently do that in the given context.

What I liked most about his piece is how, at a stroke, he removes most of the bases for those who assert we have a government debt problem, a savings problem, and a looming retirement-affordability problem.

Similarly to other economics topics upon which I have touched recently, he focuses on two things. First, he 'rehabilitates' national income accounting to bring it a point of usefulness in the debate. Second, he provides insightful measures and research in order to effectively debunk myths regarding the allegedly-perilous US economic condition.

After reading Mr. Prescott's article, I feel much better about our current economic productivity, debt and savings levels. Far better than I typically feel after listening, on CNBC, to some third-rate economic "chief" of some little-known financial institution.

Quality matters, and Mr. Prescott is the genuine article.