Saturday, April 28, 2012

Austerity Economics


Obama and his Amen corner keep preaching the danger of austerity economics. You too have expressed fear of austerity more than once. (I still fail to see how increased government spending, but at a lower rate than planned is austerity, but we can save that for later.) The prediction is the economy will tank unless government spending at all levels increases its rate of spending. As proof, Krugman pulls a graph from the St. Louis Fed FRED database.

It was a bit confusing to me since if the proposition is increased levels of government spending lead to better GDP growth, why did the increased rate of spending from 2005 through 2008 lead to a recession and why did the decreased rates of spending since 2009 lead to higher GDP growth?

Here's the same graph, but adding in year over year real GDP growth.

Just from the looks of it the connection between the rate of change in government spending and the rate of change in GDP is difficult to discern. And as you have pointed out in the past, correlation is not causation. 

For grins, I had FRED draw the graph since 1947

The correlation coefficient for these series is 0.18. However, the theory is changes in government spending leads changes in real GDP. Using the one-quarter lead the correlation coefficient falls to 0.07 and a two-quarter lead the correlation falls to 0.01. That is, there is no correlation. Keep in mind, I'm using Krugman's data set choices.

The problem, as you pointed out in your biology lesson, is our brain finds justifications to support our moral beliefs. I'll buy that, up to a point. But I find no problem rejecting the null hypothesis when the correlation coefficient is less than 0.07


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