Lessons from testifying before the GOP House: Don’t assume people know basic economic principles

I testified before the House Subcommittee on Energy and Power yesterday regarding the economic impact of new EPA rules regulating toxic air pollution emitted by power plants.  I made the simple point that when the economy is stuck in a “liquidity trap,” such regulatory changes can actually shrink the output gap and create jobs in the short-run by mobilizing idle savings into productive investments – a mobilization that today isn’t occurring through the traditional mechanism (falling interest rates) because we’re at the zero interest rate bound. The argument is far from revolutionary, but nobody else really seemed to be making it, so off to the Hill I went.

What really seemed to flummox some on the subcommittee, however, was when I stated the near-universally held view among macroeconomists that in the long run and if (and only if) the economy begins functioning well again, the unemployment rate a decade from now would best be estimated as “whatever the Federal Reserve wants it to be,” regardless of how many regulatory changes pass through Congress.

Why do I say this? Well, when the economy is working right, the Fed can cool down an overheating economy (man, to have that problem would be nice) by raising policy interest rates or can provide support to a flagging economy by lowering rates. While today’s extraordinarily weak economy has largely disarmed the Fed’s ability to provide a boost by lowering rates (the short-term policy rates the Fed manages have been stuck at zero since the end of 2008), if the economy begins functioning more-normally again then the unemployment rate will revert to pretty much what the Fed wants it to be because the tools at its disposal will be working again.*

This is neither necessarily good nor bad – the Fed may well “want” an unemployment rate much higher than is good for American workers (it’s happened before), but if that’s what they want, then they’ll get it. It’s a little hard to over-emphasize how widely held a view among economists this is. In an academic symposium (sorry, subscription required) on unemployment and monetary policy, not a single participant argued that the Fed doesn’t generally aim for an unemployment target nor did they argue that the Fed normally would not be able to hit it. Instead the argument was about the desirability of the Fed’s actual targets and/or how well the target was being estimated.

Given this consensus, it was a little odd to hear GOP representatives express slack-jawed disbelief about this statement. But it was extremely odd to hear a Ph.D. economist on the panel implicitly agree with them. And even odder was that the economist invoked a macroeconomic model run by a consulting firm, National Economic Research Associates (NERA) in their testimony arguing that that the “toxics rule” would cause economic harm.

But I’ve read the documentation of their study and their model assumes full-employment always and everywhere.** Which, (1) is why they’re wrong about the job-impacts of the rule in the short-run, when unemployment is clearly above any long-run “natural” rate and new investments will shrink the output gap and (very modestly) lower unemployment, and (2) makes it strange that they would deny that unemployment is not driven by regulatory changes. After all, their own model doesn’t admit that anything, regulatory change or anything else, can push the economy off of full-employment.

Here’s what their model actually says: because the toxics rule could cause a miniscule increase in overall prices (by pushing up electricity costs modestly), this will reduce the purchasing power of wages that workers earn. This reduced purchasing power will then cause workers to voluntarily leave the labor-force because it’s no longer worth their while to work.

The magnitudes make this argument hard to worry about. Take a worker earning around the median hourly wage – call it $15 per hour. The toxics rule cause prices to rise enough to push the purchasing power of their wage to fall all the way to $14.98-14.99 per hour (this is about the effect NERA estimates for the toxics rule – and note that this isn’t a nominal wage cut – the boss doesn’t slash workers’ wages, instead they just don’t rise relative to inflation and avoid this 1-2 cent per hour reduction). Then, because of reduction in the purchasing power of workers’ wages … a bunch of them quit.***

Sound realistic? Not really. But even if it was, this is really nothing to worry about because it’s not job loss in the sense of willing workers losing employment, it’s the strictly voluntary decision of workers to leave the labor force because they’d rather enjoy leisure. If you don’t like this reasoning, by the way, don’t yell at me – this is the argument mobilized by the anti-regulatory forces here. The same forces, by the way, that seem to not understand that their own model argues for full-employment in the long-run, just as I noted in my testimony.

All in all, a reminder that very basic economics needs to not be taken for granted in front of most audiences, even when the very economic insight in question is being actively invoked by the person you’re arguing with.

*To be jargon-y, the best bet for what unemployment will be a decade from now if the economy is functioning well again is whatever the Fed estimates the NAIRU (non-accelerating inflation rate of unemployment) is, and there is zero evidence that any regulatory change has ever affected this estimate, and little reason to think that it should.

**See page 71 in Appendix D in their report—50 percent of the increase in investments in pollution abatement equipment are assumed to reduce other investments and the other 50 percent are assumed to reduce household consumption—there is no room for simply increased economic activity to finance these extra investments, hence the model assumes full-employment.

***Of course, the NERA model does not have much to say about the benefits of the regulatory change (which are roughly 4-9 times as large as the costs) possibly boosting wages. If, for example, people particularly value spending marginal dollars on non-health care goods and services, then by freeing up money that would’ve been spent on medical care due to pollution-driven illnesses before the regulation was enacted, this could actually make people decide to work more. It’s true that lots of the benefits of the toxics rule will not show up necessarily in extra measured GDP – the value of simply not being sick, for example. But many of these benefits will indeed boost GDP – extra work days put in by people not sickened by air pollution, for example.