Prof Mankiw's "convenient agnosticism"!

Greg Mankiw is one of my favorite economists. His hugely popular text book is arguably the second-best window to learning the principles of Economics. His superstar blog has surely played a major role in enriching the debate on many political economy issues.

But his recent post explaining his ambivalence and agnosticism on extending unemployment insurance dismays me. In fact, it comes across as specious and positively disingenious, bordering on misleading and mis-directing the debate. Here is why

1. For a start, there is now enough literature on the pros (reduces household income uncertainty and props up aggregate demand) and cons (budgetary costs and lowers job search costs) raised by Prof Mankiw.

There is now ample evidence that extending the duration of UI does little to lower the marginal incentive to search for re-employment. Alan Krueger and Andreas Mueller have found that the time devoted to job search is fairly constant regardless of unemployment duration for those who are ineligible for UI.

Further, a recent study by the San Francisco Fed found negligible impact of UI extension on increase in unemployment rate - about 0.4 percentage point of the nearly 6 percentage point increase in the national unemployment rate since 2008.

2. The cases for and against any policy instrument varies depending on the broader macroeconomic environment. There cannot be a single applicable-for-all-conditions reasoning in favor or against a policy.

Consider this. The US economy is still recovering very slowly from a deep recession. Unemployment rates are on the rise and private sector job creation remains anemic. Inflation is low, aggregate demand is weak. Household balance sheets remain battered and will require more repairs. Monetary accommodation may have limited further traction. There is limited fiscal space available.

In the circumstances, doing nothing for lack of compelling quantitative evidence (of the success of the proposed intervention) and thereby letting the economy continue its present course has several dangers. The dismal macroeconomic conditions and prospects mean that the economy risks falling into a deep recession, from which recovery will be even more painful and long-drawn out. In fact, without recovery taking hold (and there is no evidence of this happening), the shares of debts and deficits will continue to grow.

The limited fiscal space available means that any stimulus spending should be directed at areas delivering the greatest bang for the buck. Money should be delivered to the hands of people who are likely to spend it immediately. A number of studies clearly indicate that among the various stimulus options, UI is among those with the largest multiplier.

3. The argument against any action on the grounds of conclusive enough evidence is all the more misleading since the inherent nature of an economy precludes any conclusive enough evidence on any reasonably complex economic policy intervention. Do we invoke this excuse to let a system take its own course, even when it is hurtling down into an abyss? Or do we weigh the relative probabilities of possible policy options and respond with the most cost-effective and most-likely-to-succeed option?

No one disputes that budget deficits and public debts should be lowered. The relevant question is whether this is the time to do so? What are the costs of contraction at this point in time? What is the cost of not doing anything and letting UI expire? Is there enough evidence in favor of the stimulative impact of UI?

In other words, the choice is between risking a deflationary recession with rising shares of debts and deficits and untold pain for the vast majority of people, and stimulating a recovery by running up short-term deficits. Reasonable people would choose the later as the lesser evil.

4.

"So when I hear economists advocate the extension of UI to 99 weeks, I am tempted to ask, would you also favor a further extension to 199 weeks, or 299 weeks, or 1099 weeks? If 99 weeks is better than 26 weeks, but 199 is too much, how do you know?"

This too has echoes of the first point. Prof Mankiw surely knows that there cannot be a not-too-high, not-too-low, and just right magic figure for the duration of UI applicable for all situations. In fact, the issue to be discussed here is not whether UI duration is too-high or too-low, but the benefits of its extension as opposed to costs. At issue is not what constitutes the optimal duration of UI, but whether fiscal stimulus is required and what is the most effective form of stimulus. If we assume that the moral hazard of UI is negligible and that we need fiscal stimulus, then the case in favor of extending UI is pretty strong.

5.

"It is also conceivable that the amount of UI offered in normal times is higher than optimal and that a further extension would move us farther from what is desirable."

On this, there is already enough evidence that US stands on the negative side of the optimum UI duration scale to Europe's positive side. So the argument on the possibility of deviating farther away from the desirable may be superfluous.

6. Prof Mankiw's argument is based on lack of "compelling quantitative" evidence on the optimum period of UI. He gives the impression that he is unable (or unwilling) to take a decision on UI till he has "compelling quantitative analysis" about "how generous the optimal system would be". Unfortunately, by setting his conditions in so comprehensive a manner, he has virtually ensured that he will never need to take a decision to support extension of UI. In any case, how much evidence is "compelling" enough?

He knows all too well that it is impossible to conclusively quantify the optimal duration of UI - not now, never in future too. In the circumtances, this logic is a convenient excuse for not doing anything. This naturally translates into letting the UI benefits expire. In other words, you vote against extension without appearing to directly oppose it!

And such reasoning has now become the convenient excuse for conservative economists to recuse themselves from supporting government interventions in many areas. The pathological opposition to tax increases too works on similar lines. Once again, it is impossible to conclusively prove whether the system falls on the upward (left) or downward (right) side of the Laffer curve.

Similarly, conservatives point to the persistent high unemployment rates and weak economic growth and argue that the fiscal stimulus measures failed. The difficulty of estimating the counterfactual condition (without stimulus) means that an argument set on such terms of reference cannot be easily refuted.

Taken to its extremes, such reasoning can be used to justify almost any position. In social sciences like economics, it is impossible to conclusively quantitatively prove that a proposed intervention or policy is required. Decisions on whether fiscal stimulus is necessary and what types of spending is required, will never be proved in a universally compelling manner.