National health spending rose a slight 3.9 percent in 2010, as Americans delayed hospital care, doctor’s visits and prescription drug purchases for the second year in a row, the Obama administration reported Monday.

The recession, which lasted from December 2007 to June 2009, reined in the growth of health spending as many people lost jobs, income and health insurance, the government said in a report, published in the journal Health Affairs.

from The New York Times

There are a couple of takeaways from this news.

First, the reduction in spending on healthcare could mean a welcome, albeit temporary relief to those governments and organizations that pay for healthcare….BUT…no real relief for state and local agencies which provide/finance healthcare for poor people. Recessions, of course, result in greater numbers of people qualifying for government-supported care.

The other point is a reminder that some portion of healthcare services are discretionary. When healthcare spending was growing by 10 percent or more each year in the 1980s, that growth probably wasn’t driven by an increase in the need for services. Likewise the slower growth over the last several years is probably not due to the population getting healthier and needing fewer services. Instead, people moderated their demand for healthcare. They put off diagnostic tests, or did not follow through on treatments or prescriptions. Going in the other direction, hospitals routinely see increases in elective surgeries near the end of a calendar year, as people have already met insurance deductibles, and decide to seek care before those deductibles are reset in the new year.

Is this good news? Not necessarily. To the extent the people put off truly necessary tests and treatments, those delays may cost us more in the long run. To some extent, though, tough economic times force us to be more cautious about discretionary spending, and there may be very little impact on long run health status. There is the old saying that if you get a cold, it will take 7 days to go away, but if you see a doctor you’ll be cured in a week! One important element of effective healthcare reform is to introduce that sense of caution in our population. It is a delicate balance – not wanting to interfere with early testing and early, cost-effective treatment, but also discouraging care that has less impact on long term health.

Prices for medical care services and supplies also stayed roughly on par with general inflation during this last year, which is a change from the decades of the 1980s and 1990s where the medical care component of the consumer price index routinely outstripped regular price increases.

I wouldn’t have to polish my crystal ball very much to predict that spending increases for healthcare will pick up speed as the economy recovers. This remains the single most important issue in our nation’s federal deficit struggles.

On a soapbox

This is a time of the year when I meet new people or get reacquainted with old friends, and once we run out of the usual “status update” conversation, someone often asks about the economy and the current crisis about the debt ceiling. I’m going to break a self-imposed guideline for this blog, and actually represent my opinions in a pretty straightforward manner. Usually my goal is to help students reach their own, informed opinion. This time – straight to the punch line…

1. The 2011 deficit (estimated at $1.5 trillion) and the accumulated national debt (over $14.3 trillion) are not the most pressing economic issues facing the country right now. They are important, but several notches down from the top of the list. This year’s deficit is just over 10% of GDP, which is high, but not crushing. There are ways to deal with these issues, as I’ll share further down. They are presented as a crisis only because the Republican Party and the Tea Party are using them to push a small government agenda. While I don’t agree with that goal, it’s fine for some to support it, but holding the economy hostage by manufacturing a crisis tied around the debt ceiling makes no sense.
2. Investment in economic growth has slowed dramatically. This is particularly true in education – at all levels. It is also true in basic research. Up until the last 20 years or so the U.S. has surfed the wave of economic change, by investing in new thinkers, and making infrastructure and other investments that will improve productivity. These seem left out of current debate options.
3. The slow recovery and weak demand for goods and services is the number one problem facing the country. The Federal stimulus is winding down, the Federal Reserve has decided that they don’t need more quantitative easing, and government at all levels is cutting employment. All the while personal consumption dropped in the most recent quarter, along with the fixed asset portion of Investment (inventories increased as a partial offset.) The uptick in unemployment and the very slow growth in employment drags down demand for goods and services. We are sliding down the same hill that the U.S. economy did in 1937-38, when Congress and President Roosevelt worried more about public concern for the debt than about sustained growth. Then we slid into a quick, nasty recession. That’s a danger now, too.
4. Inflation is not a pressing problem. The inflation we have seen this year is in food/commodities and energy. The food price spiral might well continue for awhile – I don’t have an independent sense of the true drivers. Even if food prices rise there are other elements of the Consumer Price Index that are holding steady. The rising energy prices are probably related to uncertainty about political conditions in the Middle East. Those concerns should soften soon. Inflation is something to watch out for, particularly with all of the money created by the Federal Reserve in the last three years – money created to help stabilize the economy. It is important that the Fed watch for signs of incipient inflation, driven by very high money supply, but I am confident they will act correctly and aggressively when that happens. That point is not now.
5. Bond investors are not abandoning US Treasuries for fear of default. US bonds respond to typical market forces, though they have an element of future gazing in them. If you hold a 10 year bond, and a potential buyer thinks the US might default on that bond, then the buyer will expect a higher yield (lower price/higher interest rate). That isn’t happening now. The bond market for US Treasuries is not showing signs of investors being worried about US debt.

So, what to do….

1. To tackle the most pressing problem – the slow recovery – the Federal government should be stimulating demand, through more government spending (on the part of Congress) and more quantitative easing (on the part of the Federal Reserve). Tax cuts can be part of this but they should not be across the board. The most effective, stimulative tax cut on the Federal level is the payroll tax for Social Security and Medicare. Those funds need help, and there are ways to fix them, but a payroll tax benefits mostly working people who will use the increased take home pay to consume.
2. To help with the deficit, we should remove the Bush tax cuts, and speed our exit from Iraq and Afghanistan. The Bush tax cuts disproportionately benefited higher income families, who use the extra money for non-consumption activities. When some politicians complain that raising taxes on the wealthy takes money away from job creators, there is no empirical evidence and scant theoretical basis for that claim. Along with repealing those tax cuts there are plenty of opportunities to strengthen the tax code and reduce the dreaded loopholes. Despite what many politicians say and the media parrot, this is not hard. It just takes clear headed thinking and political courage.
3. The real budget deficit challenge, at the Federal and State levels primarily, is the cost of healthcare. Increasing costs and inefficient uses of services put pressure on Medicare, Medicaid (which impacts states as well), the VA, the Dept. of Defense, and government employment costs at all levels. We should be strengthening and extending the healthcare reform efforts beyond just extending coverage – to include incentives for cost efficiency and efficacious treatments.
   
   
4. Restore and enhance funding for education at all levels. Resist the temptation to make education accountable on a short term basis, while hobbling it from producing the long term benefits derived from basic research and liberal arts education. This is an area in particular where Federal spending, even if they result in deficits, is a good investment. Cutting taxes on the wealthy is not a good use of a deficit. Deficit spending should support short term stimulative needs and long term productivity enhancements.

Credit Greg Uchrin

The U.S. has a temporary reprieve on the debt ceiling limit – tax revenues have come in higher than expected in the early part of the year, reducing the needed pace of borrowing by the U.S. government. While this has pushed the deadline for Congressional action back by a month or more, the rhetoric in Washington continues to be intense. As quick background…Congress periodically authorizes  new limits to borrowing to cover new debt. Public radio’s Planet Money has a good, short description of the ceiling. That ceiling needs to be adjusted upwards by Congress in order for the Treasury Department to sell more U.S. bonds (i.e. borrow more).

The coming vote on raising the debt ceiling is giving the Republicans a chance to push for a less-government/less-spending program. Speaker Boehner issued a challenge earlier this week, as reported in The New York Times,

‘Without significant spending cuts and changes to the way we spend the American people’s money, there will be no debt limit increase,’ Mr. Boehner told members of New York’s business and finance community. ‘And cuts should be greater than the accompanying increase in debt authority the president is given.’ Mr. Boehner said those cuts should be in the trillions of dollars, not billions.

So, what would happen if trillions, or even just $100 – $300 billion was cut from Federal spending? University of Oregon economics professor, Mark Thoma, was asked this question and wrote about it in MoneyWatch.

Thoma’s bottom line is

Even a much smaller cut, say $100 billion over the next year, would still wipe out 500,00 jobs over that time period — 2 months of job creation at present rates — and set the recovery back considerably.

For students in macroeconomics there are some good reminders of basic economic forces. I recommend reading the MoneyWatch posting. Look for these important uses of macroeconomic theory:

• The multiplier (AKA the Keynesian Multiplier). When the government spends money, that initial increase in spending adds directly to GDP. Government spending is one of the four main elements of GDP, along with Consumption, Investment, and Net Exports. Then, depending on how that money is used (spent vs. saved) those funds cascade through the economy, prompting more spending (usually personal consumption). That means the original government expenditure has an impact on GDP that is a multiple of the original amount. In theory that multiplier could be as high as 5, but applied research suggests figures between 1 and 2. Thoma makes a point that was new to me, that the multiplier can be different depending on the state of the economy – lower when the economy is closer to full employment, and higher during recessionary times. (Note to self – look this up.)
• Okun’s Law. Okun saw a relationship between changes in GDP and changes in unemployment. He observed empirically that a two percent drop in GDP was associated with a one percent rise in unemployment.

Putting it all together – Thoma estimates that a $600 billion drop in government spending over two years ($300 b in one year) will reduce GDP by two percentage points and raise unemployment by 1 percent. That is about 3 million workers losing their jobs. That would rip the guts out of our recovery.

For my students, see how many of today’s economic issues you can find in this video and compare them to our look at the Great Depression.

[The] Washington stimulus has become the policy that dare not speak its name. This wouldn’t be surprising if we were talking about a failed program. But, by any reasonable measure, the $800-billion stimulus package that Congress passed in the winter of 2009 was a clear, if limited, success.

The Congressional Budget Office estimates that it reduced unemployment by somewhere between 0.8 and 1.7 per cent in recent months. Economists at various Wall Street houses suggest that it boosted G.D.P. by more than two per cent. And a recent study by Mark Zandi and Alan Blinder, economists from, respectively, Moody’s and Princeton, argues that, in the absence of the stimulus, unemployment would have risen above eleven per cent and that G.D.P. would have been almost half a trillion dollars lower.

Now comes the incredibly difficult climb out of the recession trough. We’ve started climbing, with two successive quarters of positive real GDP growth. The newspapers, cable, talk shows, and blogosphere are filled with opinions, warnings, and predictions. I’m in no position to give a complete prescription for future economic policy, but this is an excellent time for students to be thinking through the issues. They need to separate out the fundamental building blocks of a strong economy and push aside alarmist claims.  Here’s a list of things to think about:

1. Monetary policy and the Federal Reserve: In a mild recession the Fed is our policy instrument of choice. They loosen the money supply, which in turn lowers interests rates a bit, which in turn  helps consumers buy goods and businesses to invest in the future. In the recession that started December 2007, the Fed started with this response but the depth and seriousness of the downturn outstripped the ability of routine monetary policy. They then turned to extraordinary steps to provide stability and liquidity in the financial markets, and have worked to maintain a banking system that will receive deposits from trusting depositors and make loans to worthwhile borrowers. To do this they pumped billions (over a trillion) of dollars into our system.They are now focused on how to retrieve that excess money, so that a more active economy doesn’t use it to spur inflation. They’ve been thinking about this a lot, and Chairman Bernanke insists they will be able to gradually reverse the steps they took, without sending the economy in a tailspin. The Fed also has to decide when to reverse the “normal” monetary policy and started pushing interest rates up. As I see it they are working in kind of a LIFO (last in; first out) order. The most serious and unusual interventions will be corrected first, and then the milder interest rate policies will be corrected as the economy approaches a more normal course.
2. Fiscal Policy and the Congress and Administration: Congress correctly passed a large stimulus spending bill over a year ago. The economy  needed it; routine monetary policy was not going to be sufficient to end the recession; and it would have been political suicide not to take action. The stimulus bill was not perfect. It was probably not large enough. It had some favorite son policy objectives that hindered speedy impact of the spending on the economy, and it had some not very effective tax cuts in order to garner bipartisan support.I’ve learned to appreciate a “prime the pump” analogy for fiscal policy actions like this. If you’ve ever had to use a hand pump you know that sometimes you have to add water in the top in order to get the process working. Government stimulus funds are like priming the pump. They immediately add something to the GDP, since government spending is one component of GDP. The real test of a fiscal stimulus is whether the priming works. In an ideal case, the initial injection of spending prompts a cascading series of new spending decisions in the private sector. This is the essence of what my students learn as the multiplier effect. New spending on roads means more wages for road workers, who hopefully become more likely to spend, and the establishments where those workers spend have the same opportunity. There are plenty of signs that the initial stimulus money started improving GDP. Whether that money has successfully primed the pump is an open question. Some policy experts are calling for more stimulus – a second priming. Others (not including those who object on philosophical grounds to more government spending) worry that another fiscal stimulus would boost the economy just as it is getting better on its own, and could spark an inflationary spiral.There has been a flurry of “job bills” discussed by the administration and Congress. Many of these are responses to a perceived (probably real) concern among the American voter that jobs aren’t coming back quickly enough and something needs to be done about it. I don’t know enough about them to comment thoughtfully. Based on past performance it is easy to guess that some proposals will do little to make a permanent shift in the employment picture, and that some will have serious side effects. One quick example – just about any “Buy American” restrictions will hurt our economy in the long run and have minimal benefits in the short run. The Smoot-Hawley act passed in the early years of the recession is our number one example of the problems of drawing up the bridges and protecting our own workers at the expense of other world markets. On the other hand jobs bills that can reduce structural unemployment through retraining, relocation, and other adaptive strategies are money well spent.
3. Federal Deficit and Debt: This is the trickiest balancing act. It also has the most heat and the least amount of light in media discussions. Here’s what the Congressional Budget Office says about the near term situation:

CBO projects, that if current laws and policies remained unchanged, the federal budget would show a deficit of $1.3 trillion for fiscal year 2010. At 9.2 percent of gross domestic product (GDP), that deficit would be slightly smaller than the shortfall of 9.9 percent of GDP ($1.4 trillion) posted in 2009. Last year’s deficit was the largest as a share of GDP since the end of World War II, and the deficit expected for 2010 would be the second largest.

One way to look at this issue is represented by Paul Krugman:

Contrary to what you often hear, the large deficit the federal government is running right now isn’t the result of runaway spending growth. Instead, well more than half of the deficit was caused by the ongoing economic crisis, which has led to a plunge in tax receipts, required federal bailouts of financial institutions, and been met — appropriately — with temporary measures to stimulate growth and support employment.

Gregory Mankiw is less happy about projected deficits:

The troubling feature of Mr. Obama’s budget is that it fails to return the federal government to manageable budget deficits, even as the wars wind down and the economy recovers from the recession. According to the administration’s own numbers, the budget deficit under the president’s proposed policies will never fall below 3.6 percent of G.D.P. By 2020, the end of the planning horizon, it will be 4.2 percent and rising.

My own take? Closer to Krugman than Mankiw, but I worry that a partial economic recovery or some call for fiscal stimulus will produce not-well-thought-out-spending plans. These won’t help much, in terms of recovery, they are likely to be persistent beyond the current economic problems, and they won’t help re-establish a deficit closer to 4-5% of GDP.

As a quick review for my students – Our most recent and serious recession came about largely because the prices of real estate and houses accelerated dramatically, and out of proportion to other purchases or investments that the average American could make. When that bubble of high prices popped, financial institutions which had been lulled into thinking their real estate-related investments were safe, found their balance sheets decimated. This has happened several times before in our country’s history, including the technology stock bubble in the late 1990s and 2000, and as far back as the 1800s for railroad properties and precious metals. Even in the 17th century speculation in tulip bulbs caused an economic collapse.

There are two main criticisms about Federal Reserve actions in the last 3-4 years:

1. The Federal Reserve kept short term interest rates too low, for too long a time following the mild recession in 2001. Critics argue that this monetary policy encouraged risky borrowing and unnaturally inflated housing prices.
2. The Federal Reserve was lax in its oversight and regulation of the financial services sector – both over institutions, like banks, and over the risky mortgage lending practices. Regulatory faith in the power of market mechanisms was unearned, and institutions made what we now see as irrational moves.

At a meeting of the American Economic Association in Atlanta this week, Chm. Bernanke rejected the idea that monetary policy caused the housing bubble, but he did acknowledge that weakness in regulatory efforts played a major role.

U of Oregon professor, Mark Thoma, has a nice piece on these issues:

I have been more defensive of the Fed’s actions both before and after the crisis started than most, and I want to talk about why recent criticism of Bernanke and the Fed for their failure to use regulatory intervention to stop the housing bubble is correct, but perhaps directed at the wrong target.

I’ve gotten on this soapbox before – though the Federal Reserve is a human, fallible organization it is staffed and led by thoughtful professionals and should continue to be protected from political second guessing. There is no member of Congress, including Rep. Barney Frank, who can bring more intellectual and effective knowledge to bear on this issue than Bernanke and his staff.

The central quote…

In fact, right now men’s underwear sales suggest that things have bottomed but not started to recover.

I dare you not to read more.

Wall Street Journal 6/3/09

Revenues to state and local governments are sensitive to economic conditions. Sales taxes are tied to purchases, of course. Income tax revenue is often more problematic. If a state, like Oregon or California, has a progressive income tax structure (higher income citizens pay a higher tax rate) then when incomes drop not only do taxes go down but they go down even faster as people fall into lower tax brackets. Oregon is particularly vulnerable because it does not have a sales tax. California has been buffeted by this phenomenon – seeing wide swings in revenue as economic cycles pass through.

On the costs side economic recessions increase demand for state and local services and programs. These are part of automatic stabilizers, and help a bit with increasing aggregate demand. They cost money, however.

And yet, unlike the federal government most state and local governments are prohibited from running or planning a deficit. They must operate in the black, even in the face of seriously declining revenue and increasing costs.

Not a pretty picture.

Every so often, history serves up an analogy that’s uncomfortable, a little distracting and yet still very relevant.

In the summer of 1933, just as they will do on Thursday, heads of government and their finance ministers met in London to talk about a global economic crisis. They accomplished little and went home to battle the crisis in their own ways.

More than any other country, Germany — Nazi Germany — then set out on a serious stimulus program. The government built up the military, expanded the autobahn, put up stadiums for the 1936 Berlin Olympics and built monuments to the Nazi Party across Munich and Berlin. [...] Germany did escape the Great Depression faster than other countries. Corporate profits boomed, and unemployment sank (and not because of slave labor, which didn’t become widespread until later).

In addition to this analogy, which I recommend reading in more detail, there is an interesting graphic that helps understand the different approach the United States is taking to stimulate demand, versus its European partners.

Most industrialized countries have laws on the books that automatically increase government spending when the economy is slow. Spending on food stamps, unemployment insurance, and other benefits to poor people go up as more people qualify for assistance. And with a progressive tax rate system, a decline in income not only means lower income taxes, but a lower income tax rate. (The result taxes drop more rapidly than income.) We call these phenomena automatic stabilizers. The dark portions of the bars above show these automatic increases in government spending. The lighter colored portions show discretionary spending – which requires an act of the legislature. Great Britain and several European countries have stronger social safety nets, so their automatic spending is greater as a percentage of GDP. The United States is less. So, we are more likely to increase discretionary spending in hard economic times. The members of the European Union, as Leonhardt points out, have been willing to increase government spending, but not to the degree that we have in the U.S. There are more complicating factors – see Germany as an example – but this is an illuminating discussion.