My Paper on the Budget Deficit and Uncontrollable Inflation

#1
I wrote a paper for class about the future problems of our current deficit. I figured I'd share it with you guys, hoping some of you are econ junkies, or are concerned about economics in general. It's a paper that deals with John Cochrane's 2011 paper Inflation and Debt, and my summary of it. Bear in mind this was done at the 11th hour ( 2500 word essay in 3 hours, eek! ), but it represents some of my insight of the current crisis. Comment, criticize, and enjoy!




John Cochrane’s paper, Inflation and Debt (2011), issues a stern warning concerning how our rising debt may contribute to future inflation. In Inflation and Debt, we learn and attempt to understand the approaches taken by both Keynesian and Monetarist economists to predict and prevent rapid inflation. Cochrane points out key issues that both breeds of economists miss in their evaluations of inflation, and how policy makers can have a better understanding in assessing when and why inflation can strike. The purpose of this paper is three-fold; we will first understand and summarize Cochrane’s main arguments about why Keynesian and Monetarist economists miss the mark in predicting inflation. Next, we will summarize and evaluate Cochrane’s view that government fiscal policy and risk of insolvency contribute to inflation. Lastly, we will determine whether Cochrane’s views can translate into meaningful and useful advice in future inflationary outlook.


Inflation: A Silent Assassin


In the first portion of Inflation and Debt, Cochrane details why inflation should be considered a serious problem that cannot be brushed aside by today’s economic minds. Cochrane argues that most economists and commentators don’t seriously consider inflation to be a concern at this moment, as inflation has remained relatively low on all historical metrics. Support for this view is that yields on long-term treasury bonds, which naturally should rise when inflation is expected to rise due to interest-rate risk ( the risk that investors take when inflation is expected to rise in the future), are at half-century lows. To further that point, Cochrane points out that the Federal Reserve issued a statement proclaiming that “…measures of underlying inflation have trended lower in recent quarters”. Cochrane notes, however, that the Fed’s view of the risk of inflation is too narrow. He views inflations as, historically, the ‘fourth horseman’ of economic apocalypse. Instead of focusing on monetary policy and price level, Cochrane points to inflation being used by governments to control the amount of debt they owe. When inflation rises, the relative price of the debt that a government holds falls. In effect, this means that the government may have incentive to increase inflation as debt becomes unmanageable. So monetarists who view inflation through the lens of money supply and Keynesians who point to interest rates to understand inflation, are missing the factor of government debt in their predictions of future inflation. Both sides, however, believe that the Fed can intervene to control inflation and that the American government can remain solvent, two ideas in which Cochrane seeks to question in Inflation and Debt.


Inflation: A Keynesian Approach


Cochrane begins his critical analysis of current inflationary thought by detailing how Keynesian economists believe inflation in controlled by the Fed. Through changes in overnight interest rates, Keynesian economists believe that the Fed can control economic growth, as to not grow too quickly (inflation), or too slowly (recession) through monetary policy. Cochrane, however, believes that there is very little correlation between metrics of economic ‘slack ‘(unused productive assets, like cash), and inflation. If this were the case, Cochrane notes that Zimbabwe would be the richest country in the world with 11,000,000% inflation. Furthermore, he criticized the causative link that the Fed places between inflation/deflation and stack/tightness. To counter this problem, Keynesian economists point to expectations of changes in inflation to actually help cause inflation or prevent it. In this view, expectations of inflation can actually worsen it if those expectations are not grounded in reality. If, for instance, the market reacts to a short term blip in inflations as a sign of further long-term inflation the market will actually contribute to long-term inflation. However, Cochrane notes that studies, surveys, and long-term interest rates did not predict serious inflations, like in the 1970s. Regardless, Keynesians believe that to implement an ‘anchor’, or a solid prediction of future inflation, we only need the Fed to announce such a prediction for the market to respond accordingly. This course of action is proposed assuming that the Fed will respond swiftly and boldly to changes in real inflation by raising and lowering interest rates. Cochrane disagrees with this sentiment, claiming that the average person doesn’t really pay attention to the Fed’s inflationary targets. Instead, he argues that our relatively stable expectations the past 20 years may be due to sound fiscal policy, as unmanageable governmental finances are usually a precursor to rapid inflation. With this in mind, he then turns his attention on Monetarists’ misunderstanding of inflation.


Inflation: A Monetarists Approach


Contrary to Keynesian economists, Monetarists believe inflation results in too much money in a market that has too few goods to purchase. As such, the price of the goods will increase to adjust to a true value of the good. Cochrane explains that this gives Monetarists a good reason to be concerned; the total reserves in Fed accounts amounts to a total of 1.6 trillion USD, doubling in three years. While these reserves are still deposited in the Fed, they do not contribute to inflation. However, if those funds leak out of the Fed’s accounts, then they could spark massive inflation. Cochrane doesn’t believe that money supply is the source of inflationary danger, even with this in mind. He notes that modern metrics measuring money supply of M1 and M2 do not show much of a correlation with rises of inflation. Cochrane explains that the reason Monetarists view the source of inflation improperly is because they view the demand for money as constant. This view is misguided as the demand for money can rise and fall when the demand for liquidity rises and falls; when liquidity is favored, people will demand money more, and vice versa. To further that point, since interest rates have been near zero since the financial crisis, the Fed has begun paying interest on reserves in Fed accounts. If the total yield on interest bearing bonds is equal to the yield gained from keeping reserves in a Fed account, bank managers will choose to keep those funds in the Fed accounts to enjoy the relatively more liquidity. As such, Monetarists hold the belief that the Fed can still control inflation by adjusting its interest rates on reserve accounts, and by selling bonds. Like Keynesians, monetarists assume the government to be solvent and generally disregard government deficits and debt when they analyze future inflation. It is this assumption that we now call to question.



 
#2
Inflation: Cochrane’s Approach

Cochrane begins detailing his views on the link between government fiscal health and inflation by pointing out the massive deficit the United States finds itself in today. To this effect, the overall federal debt will be at 100% of GDP in 2011. While many economists believe that ratio of under 100% aren’t considered dangerous, Cochrane notes that mindset is only viable if there is a good outlook on the government’s ability to pay off its debt in the future. Due to the aging baby-boomers contributing to increased future social security liabilities, the fiscal outlook of the United States looks as bleak as it does today, if not more. These ‘off balance sheet’ promises which include promises to not let banks fail and promises to not let local governments become insolvent give a terrifying view of future fiscal health. With this in mind, Cochrane proposes that these future debts may contribute to the government needing to reduce its debt by printing out more money to pay of those liabilities, increasing inflation outside of the Fed’s control. This process begins when the government prints more money than it takes in from taxation. In a normal times, the government would issue these bonds, pull the money out of circulation, and pay for those bonds with future tax dollars. This, in effect, contains inflation to manageable levels. However, when the government must pay off those bonds by issuing new bonds, inflation begins. Eventually, people will catch on that the government will need to begin printing money to pay of the rising amount of debt, and the expected inflation will rise as well. As expected inflation rises people will choose to invest in assets like stocks and real estate, increasing the price of those assets as demand rises. This rise in price will contribute to a rise in total price level, and cause inflation. With this in mind, Cochrane notes that Keynesians are correct in purporting that expected inflation rates could affect inflation itself, but wrong in assuming that it’s because of ‘anchoring’. While a Keynesian would argue that expected inflation contributes to inflation via the actions and promises of the Fed, Cochrane argues that expected inflation contributes to inflation via the deficits and actions of the US government.

With Cochrane’s idea of how inflation happens and how expected inflation can contribute to real inflation, we can now delve into how interest rates relate to inflation. In modern post-recession years, the Fed has kept the interest rate low in hopes of not suffocating economic recovery. Investors are able to invest in such a low-yield investments because of the relative safety and liquidity of US debt. However, in recent years, the government has pledged to throw their money behind entitlement programs and Social Security over interest payments if given the dichotomy. If the US government loses the trust that investors have in the security of its debt by missing interest payments, the government would need to pay a risk premium on top of the normal interest rate. In this case, interest rates would naturally rise and as a result, the government deficit would increase. As outlined before by Cochrane, increases in the deficit are correlated with increases in inflation. With this in mind, we propose that both expectations of future surpluses and deficits, as well as an increase in interest rates, reinforce each other to drive greater, and more rapid inflation.

As these factors begin mounting investors begin losing more and more confidence in US debt and, like in the case of banks in the great depression, investors will ‘ run ‘ away from US backed debt, as well as the dollar itself. Unlike banking runs, however, the short term government debt cycles over the course of a few years. As such, the ‘run’ from the US dollar would take place over the course of the debt maturity. Likewise, this loss of confidence wouldn’t happen overnight; Confidence loss would mount over a number of years. As a natural consequence of runs, there is a measure of unpredictability in forecasting them. Cochrane notes that “people don’t run when they hear of bad news, but when they get the sense that everyone else is about to run. “ With this in mind he puts forth the disclaimer that his views are not a forecast of inflation, but a warning of what continued government deficits and fiscal instability could mean for inflation. He does say that the US is primed for this sort of inflation, and that major market players like PIMCO are already pulling out of US debt.

Keynesian economists see the Fed as the major controller of inflation and monetary policy in the United States. In Cochrane’s analysis, however, the Fed is causally inefficacious. This is because the fed controls monetary policy through US instruments of debt, like the dollar and US bonds. When the confidence and value of these instruments drop the fed is powerless to control these processes, as they can only trade one form of US debt for the other. They have no control over the confidence in the ability for the government to controls its deficits. In this instance, the Fed is simply the middle man between the treasury and the investor. If the Fed wants to implement a plan to reduce inflation, it needs the Treasury to help realize that plan by raising additional funds to pay off US debt. This ability for the Fed to implement policies to control inflation like a Keynesian or Monetarist would have you believe is contingent on the assumption that there is coordination between the monetary policy makers of the Fed, and the fiscal policy makers in Washington. Cochran points to the actions of the European Central Bank in attempting to stabilize inflation and unstable member economies. The EBC is buying a lot of Irish, Portuguese, and Greek debt in an effort to help those member nations to remain solvent. If those nations default, their currency will take a hit, the EBC would not have enough value of those debt instruments to get equal value on the Euro. Thus, Cochrane reveals his conclusion that the inflationary problem is not a monetary problem, but a problem with fiscal policy, deficit, and debt-ballooning.


Inflation: A Cochrane Solution


With this framework for inflation being a fiscal problem, Cochrane gives a number of ways policy makers can go about fixing the deficit, and restoring faith in the US debt instrument. He first recommends that the government cuts back and reworks entitlement programs like Medicare. Reworking of the framework can convince bond markets that the United States is taking steps in the right direction to ‘ get out of the red ‘, and re-ignite confidence in a default-free American future. Secondly, Cochrane suggests that we need to turn fiscal policy in the direction of long-term growth. Small steps taken now, he argues, can have vast payoffs in the future if compounded correctly. In a similar vein, if there remains little or no economic growth in this decade investors will continue to lose confidence in US fiscal policy. This loss of confidence could future exacerbate the rising interest rate component of inflation. Lastly, Cochrane argues that we must revise our regulatory and tax system to foster business growth. He claims that our taxes rates are too high, while our revenues are too low. Cochrane suggests that we need to devise a tax system that does the opposite of this; a system that maximized revenues while minimizing tax rates. Likewise, Cochrane argues that we need to give regulation agencies like the EPA less power over policing businesses, as this can provide disincentives to hiring of new employees, and reinvestment.


 
#3
Discussion/Analysis


John Cochrane highlights many of the key issues economists have looked past when dealing with inflation in Inflation and Debt 2011. This section will deal with a critical analysis and discussion of John Cochrane’s views of fiscal policy and inflation. It should be noted that these ideas of fiscal policy being the main contributor to inflation is nothing new. Austrian Economist Ludwig von Mises voiced the same concerns as Cochrane in his 1951 remarks in the Commercial and Financial Chronicle, regarding the government using inflation to control its debt:

Inflation, an increase in money and credit, is certainly not a means to avoid or to postpone for more than a short time the need to resort to taxes levied on people other than those belonging to the rich minority. If, for the sake of argument, we leave aside all the objections which may be raised against any inflationary policy, we must take into account the fact that inflation can never be more than a temporary makeshift. Inflation cannot be continued over a long period of time without defeating its fiscal purpose and ending in a complete debacle as was the case in this country with the Continental currency[1] .



In a similar vein, Nina Budina and van Sweder Wijnbergen argue that fiscal policy contributed to the massive inflationary problems that arose in the 1990s in Europe[2]. While the idea is not new to the world at large, Cochrane’s Inflation and Debt puts these issues in context of how they might apply to a hegemonic and economic super power like the United States. He challenges us to not view the US as a government entity that cannot, under any circumstances, default. Instead, he proposes ways that the fiscal policy makers can attempt to close the deficit gap, and avoided rapid and unstoppable inflation in the future. While Cochrane’s views on the issue bring a fresh perspective on the inflation debate, there are some critical points that need to be further explored to give his ideas merit.


The first is that inflation is not necessarily a bad thing. Janet Yellen, current president Barack Obama’s nominee to lead the Fed, has argued:





That a little inflation is particularly valuable when the economy is weak. Rising prices help companies increase profits; rising wages help borrowers repay debts. Inflation also encourages people and businesses to borrow money and spend it more quickly. “[3]


Instead, in August of 2013, inflation remained at 1.2%; far short of the 2% target of the fed. For this, Cochrane’s analysis of the failure of anchoring was correct. Business owners and bankers may benefit from such inflationary rises as 6%, but people may rush out and spend money to obtain value holding assets, further contributing to inflation that spirals out of control. Alan Greenspan, former Fed Chairman, projects that such a prospect could result in double-digit inflation. However, the lack of target inflation can actually be detrimental to the economy at large. So here, the goal is to foster ‘healthy‘inflation; not avoid it all together. Cochrane, however, does not necessarily state that inflation is a bad phenomenon; only that we should take steps to avoid it spiraling out of control. To that effect, the US government is not on the brink of a fiscal collapse, and there is still time to avoid rapid inflation while minimizing the economical strain the new fiscal policy could have on the economy.

In effect, Cochrane’s views are more or less a wake-up call to policy makers that their actions have an effect on the economy at large. He pushes the point that controlling inflation is not the sole responsibility of the Fed; that fiscal policy and monetary policy must work hand-in-hand to help prevent out of control inflation. To help maintain confidence in the ability for the US to pay off its debt, fiscal policy makers must work in bipartisan union to reform the programs needed to optimize revenues gained through taxation. While Cochrane’s suggestions and analysis is most likely not the only factor of uncontrollable inflation, policy makers would do well to take greater responsibilities for not only the monetary, but the fiscal health of the US in the future. If not only for inflation, but for maintaining the world renowned power and stability that has fostered so much growth and prosperity we all enjoy today.




[1] http://mises.org/efandi/ch20.asp



[2] http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-2298



[3] http://www.nytimes.com/2013/10/27/b...-helps.html?src=me&ref=general&pagewanted=all
 
#4
Hey Layace,

I love that a 23 year old is writing an econ paper that is counter to the Keynesian viewpoint. I don't know but I believe the Keynesian doctrine is still the main fare at the collegiate table.

I think at this point, regardless of what we're being told, it's clear that the US can't pay back their debt (especially if you consider the unfunded liabilities). We have the greatest fiscal crisis in the history of the US and we haven't had a budget in years. Ross Perot ran for President back in the 90's. His platform was getting fiscal control of this mess. The Grace Commission was brought in during the 80's to get our spending under control. Then the Gramm-Rudman-Hollings Act in 85 also trying to get control of the spending. Every president during and since that time totally violated the findings of this former work. We are not going to pay back our debt.

What I'm curious about and I'd love to hear your opinion on as well, why is this debate still alive on our campuses? Certainly Cochrane realizes this will never be paid back. Why does he deem it necessary to even get into the dialogue? I'm very curious as to whether we're going to see a great inflation or deflation. Certainly inflation will show itself at some point so that we can pay our debt back. We don't have the stomach to go public with the idea that we're bankrupt and want terms with those holding our paper (think China - let's go to war with them instead {stuck on stupid we are}). The process is happening though. Numerous countries are now doing business outside the dollar based currency. That will be the death of the dollar and this false economy we're running on.

Anyway, a couple ideas that came to mind after looking over your paper.

Best,

Matt
 
#5
1) Why no discussion about unemployment?
2) What happened to this?
3) Does this matter?
If the United States had per person health care costs that were comparable to costs in other wealthy countries (all of whom enjoy comparable or better health outcomes), then we would be looking at long-term budget surpluses not deficits.
 
#6
Yes, Keynesian thought is still very prevelant in the collegiate atmosphere, but that's beginning to change. That class of economic thought worked when the US was still stable, and our biggest problems were controlling the ebb and flow of the business cycle. As I referenced in my paper, this is the first time that we've had to seriously consider that the US may default on its debts, so apparently all avenues of ourpredominately Keyesian models ( which are used extensively by the Fed ) have been exhausted and people are looking elsewhere.

The unfunded liabilities is potentially what could spark the uncontrolled inflation. Eventually, the US will need to look for other sources of revenue besides borrowing. This will in turn lead to either a raise in taxes, a cut in government spending, or printing out more dollars. Remember that government debt is incredibly sensitive to inflation, meaning that if investors predict large amounts of inflation in the future, they're not going to invest in any form of US debt ( the dollar, or bond ). Theyre going to purchase better value holders like physical capital. So those unfunded liabilities that you talked about ( future social securities, etc. ) could spell disaster if investors don't have the confidence that the US can wheather through them.

The debate is very much alive, and even some of my professors ( who should be counted among the holdest harbingers of Keynesian thought ) are some of it's biggest critics right now. Economists in general have been relatively fiscally conservative, but we don't see our problem as being one of economics. It's a political problem. The economy is easy to fix if you handed the reins to an economist who doesn't give a crap about politics and just does what it needs done. The problem is, the vast majority of Americans think they're experts on the economy when they really have no clue what they're talking about. So any change, especially the ones that are going to hurt very badly, will be receive fierce protest from the American people. Outsourcing? Great! We're exploiting comparative advantage! That way America can go back to doing what was great at; investing more human capital into R&D ( we're still the world's leader in technology ) and services. But you have a large portion of American citizens who frown upon outsourcing.

It's almost certain that there will be some form of inflation in the future. Which isn't a bad thing; it's necessary. The question is, will the US be able to control it alone through the FED adjusting interest rates? I don't think it will be that simple, but if we can stretch the pain out over, say, 20 years I feel that Americans will barely feel the impact. Most of the problem is that we're spending too much money on things that don't foster growth. It's a long heralded concept in economics that investment in education and infrastructure promote far more growth than any spending on social security and other spending. The way out isn't to whether the storm, or to stop spending. If you cut spending, then firms and people leave the US to find another another country more conducive to their business or personal structure. The way out is to outgrow our deficit. In recent years, spending has begun to be focused on education and infrastructure which is a great sign. Whether that's going to be enough to counter our present and future deficits? I don't know.

Kay,

Unemployment and inflation is a touchy subject. Look at today's less than 2% inflation ( it's been that way because of the Fed's low interest rates ). Inflation remains at almost all time lows, but unemployment and underemployment are still high by all metrics. Firms took the chance in this recent economic crisis to restructure their firms into high functioning, technologically efficient machines. Gone are the days of the comfortable reception jobs that paid high. Unless you have a technical skill, or are highly educated, middle-class jobs will be without of a persons reach. That's why there are so many unfilled jobs, but so many unemployed people. The pegs just don't fit the holes right now.

Deficits do matter. If anyone claims they don't, they're wrong.

Health-care costs are huge in future unfunded liabilites. The ACA is trying to fix that by internalizing the externality presented by the uninsured. Below is a copy of a paper that I wrote for another course ( Price Theory ), about the ACA.
 
#7
Econ 310

Are We Better Off With ACA?

The history of subsidized healthcare in America is one of both caution and convolution. With healthcare prices skyrocketing out of the control, many argue that the need for a proper subsidy has never been as clear. On March 23, 2010, President Barack Obama signed into law the Affordable Care Act (ACA), taking a gigantic step in the goal of government subsidized health insurance. The ACA is a package of mechanisms aimed at reducing healthcare costs for both the government, and the population. In the course of this paper, we will analyze the various mechanisms behind the ACA, explain why such an Act was deemed necessary, and use economic analysis (specifically price theory) to determine how price-consumption and maximum utility may change for the taxpayer.

The ACA itself is not just a subsidy in healthcare – it constitutes a large package of subsidies, regulations, and mandates for healthcare providers, insurance companies, and consumers. The first, and some would argue largest, goal of the ACA is to increase coverage to the 47 million Americans who were uninsured in 2012. The ACA seeks to expand coverage to these uninsured by both expanding Medicaid Eligibility, and subsidizing state-based insurance exchanges. Estimates project that this will increase coverage by 32 million, with the remainder of the populace being illegal immigrants, citizens who opt out, and those who are exempt from paying the annual penalty. The need for an expansion of healthcare coverage may sound counterintuitive from an economic perspective. All evidence suggests that healthcare is a normal good that is income elastic. This means that as income rises, consumption of healthcare will rise as well. However, as healthcare becomes more and more unattainable for low income consumers, while simultaneously income levels drop further, there comes a threshold that makes less consumption of healthcare unattainable. In some cases, consumers cannot choose to not consume healthcare; accidents happen. Whether it be a sniffle or a heart attack, medical bills can put a cost on the consumer far greater than what they can afford with their income level. The consumer is then left with 3 options: pay the bill off in payments over multiple years, apply for retroactive health insurance, or simply not pay the bill. With relatively strict laws against collection agencies, most consumers will simply choose to notpay the bill, as evidenced by the $41.1 billion in unpaid medical bills in 2011. Not only does this cut into the profits of the healthcare provider, there is a direct effect on quality of care and benefits of other consumers as well.

Presumably, at the beginning of the year healthcare facilities provide an estimate of losses from uninsured non-payers. These will naturally factor into their budgets for the year, which also include funding into medical equipment, staffing, and other physical and human capital. To compensate and account for losses, healthcare providers must do one of two things: raise the cost of procedures, or cut the cost of expenses. Most choose to cut the cost of expenses, and as such, the quality of care provided to insured payers may fall. Wait times will be longer, medical practitioners may be overwhelmed, and administration tasks become more susceptible to error. Not only is there an intrinsic cost to correct these errors in the form of lawsuits and reduced productivity, but there is loss of life as well. In economics, we refer to these costs being bore by nonpayers and healthcare workers as externalities. While nonpayers receive the benefits of the healthcare, it is the other agents that bear the costs. The ACA seeks to internalize this externality by forcing nonpayers to purchase healthcare, or pay a fine. This, in effect, shifts the costs off of the healthcare firms and other consumers back onto the previously uninsured and their respective insurance companies. The hope, then, would be that the medical industry could begin lowering the cost of healthcare as losses diminish over time. This makes healthcare cheaper and more consumer friendly, increasing the relative income of all consumers. In a similar vein young people, who are the least likely to consume healthcare or have insurance, will now be forced to pay to purchase healthcare or be fined. While not necessarily the most libertarian or fair concept, it will help partly offset the relatively higher cost of healthcare at older ages, where the indifference curve in relation to healthcare is much steeper.

To implement and extend coverage to the uninsured, the ACA establishes state-wide insurance exchanges, and increases the poverty threshold for Medicaid. In effect, one can visit the website associated with one’s state to shop for insurance plans within their particular income and price range. There, a consumer can find out eligibility for subsidies on private plans, or see if one is eligible for Medicaid. The purpose of an open market place is to remove the restrictions and market failures of the previous method of health insurance, such as medical bankruptcies, coverage limits, affordability, etc. Likewise, insurance companies will be entirely prohibited from denying health insurance to those with pre-existing conditions. With those parameters in place we can begin to look at how the healthcare is actually subsidized, and how it can benefit or harm the consumer.

It should be noted that the ACA subsidy portion does not apply to all consumers equally. Consumers with income levels under 133% are eligible for Medicaid, while the subsidy only applies to families that lay between 133-400% of the poverty line. To be eligible for the subsidy, one much purchase and insurance package conducive to a fixed amount based on family size (in general, 15,000 a year for a family of four). Once the required package is purchased the government will then subsidize a portion of the healthcare, with low income households
 
#8
receiving a larger subsidy than high income households. This would imply that households between $30,000-90,000 per year are eligible for the subsidy, and only if their employers do not offer healthcare. With median income of $60,000, subsidies will be extended to all lower class, as well as a large portion of the middle class. The effects of such a subsidy range through all preferences and indifference curves of each individual consumer. Naturally, for those who prefer to consume healthcare and don’t already have it, such a subsidy will benefit them more than a consumer with less of a preference to healthcare. For those that have a weaker preference for healthcare, such an excise subsidy will carry far greater deadweight. That is, the benefit they are receiving from the subsidy is far under that of the cost of the subsidy, presenting a greater ‘loss’ to the government. This lies in contrast to families that have a high preference for healthcare, but can otherwise not afford it. For these families, benefit received from the subsidy will be much greater, and the deadweight loss less severe. Arguably, most rational families will fit into this category.

When discussing subsidies, we usually never consider the consumer as worse off than before if they do not have to pay taxes to finance the subsidy. That is, if the consumer finds no utility, or a net loss of utility from the subsidy, they can simply choose to not accept it. The ACA, however, presents a different picture than normal subsidies. Like public schooling, the ACA forces one to consume a specific product but with an exception; the consumer still must pay a premium, or subsequent fine. This implies that, unlike most other subsidies, the healthcare subsidy can present an unavoidable loss of utility for specific consumers. Take, for instance, people of a younger age. Because of comparatively fewer health problems in the younger years of adulthood, preference for healthcare lies on a much flatter indifference curve that those of an older age. When the excise subsidy comes into effect, utility is lost as the consumer is forced onto a lower indifference curve by nature of the corner solution. Likewise, one can choose to forgo the subsidy and pay the fine, but this also makes the consumer worse off than before. Graphically, this would simply shift the income line down proportional to the amount paid in fines. In both cases, the consumer is on a lower indifference curve, and less well off than before.

With this analysis in mind, we can begin asking whether the benefit to the uninsured outweighs the net benefit loss from consumers with flatter indifference curves. For the purposes of this paper, we will assume that those with the flattest indifference curve fall within the ‘young adult’ age bracket, and represent 27.4% of all uninsured. 19.7% of uninsured consumers are legal and illegal immigrants exempt from the subsidy (legal immigrants residing in the US for less than five years are ineligible). This leaves us with 52.9% of uninsured consumers that have far steeper indifference curves than the 27.4% of young adults. Economically, and from a purely consumer benefit point of view, the subsidy will in fact increase net benefit. The loss of benefit is far outweighed by the gain in benefit from older consumers. The cost to the government, specifically the deadweight cost, is hard to determine as there is no hard data on whether a consumer will choose to take the penalty, or the healthcare. Likewise, until all eligible consumers receive the subsidy, there is little data to compile.

Now that we have analyzed the benefits and costs to the consumer, we can theorize and predict some of the costs and benefits to the insurance issuer. Most metrics place the cost of insurance premiums as lower than before the ACA. Such analysis will be hard to pinpoint for reasons mentioned below. The first is that we have relatively little information on the health of the uninsured. The ACA comes prepackaged with a mandate stating that no longer can anyone be denied health insurance based on pre-existing conditions, and such a consumer’s premium cannot be subject to a cap over their lifetime. Because insurance companies evaluate and issue policies based on risk analysis, providers will now be forced to take risky consumers that will assuredly represent a net loss. However, we also must take into account that consumers with a lower preference, and presumably a lower consumption rate of healthcare, will also be purchasing the same services with the same costs. In effect, insurance providers will be forces to take on clients with higher risk at a loss, but also be benefited with clients who would otherwise present much less risk at a gain. We won’t have much access to this data until the coverage comes online, but it will be interesting to check profit margins for subsidy insurance providers in the future. In recent data, insurance policies for already insured consumers rose in price as well. It will be time before the true effects on profits and losses can be determined.

In a similar fashion, insurance companies are now required to spend 80-85% of all insurance premium dollars on costs associated with healthcare. The other 15-20% may be used for administration and profit making costs. Like the increase in plans to risky consumers, it is too soon to tell whether or not this will harm insurance companies in the future. Recent articles and projections place insurance issuers that are large players in ACA, like WellPoint, much in the green category when profits and losses are realized at the end of 2014.

So far, we have graced over by far one of the biggest factors in the ACA. How will such an act affect the government in terms of deadweight loss and normal cost? To analyze this, we must first make mention that short term costs are less important than long term costs. If short term costs can benefit us a gain in the long run, then that situation would be more ideal. As follows are two divergent opinions: one from Jonathan Cohn, a health policy analyst, and the other from Jonathan Gruber, one of the consultants who helped develop the ACA:

“CBO doesn't produce estimates of how reform will affect overall health care spending — that is, the amount of money our society, as a whole, will devote to health care. But the
 
#9
officialactuary for Medicaredoes. The actuary determined that ... the long-term trend is towards less spending: Inflation after ten years would be lower than it is now. And it's the long-term trend that matters most ... [The Affordable Care Act] will reduce the cost of care—not by a lot and not by as much as possible in theory, but as much as is possible in this political universe.” – Jonathan Cohn

“The real question is how far the ACA will go in slowing cost growth. Here, there is great uncertainty—mostly because there is such uncertainty in general about how to control cost growth in health care. There is no shortage of good ideas for ways of doing so ... There is, however, a shortage of evidence regarding which approaches will actually work—and therefore no consensus on which path is best to follow. In the face of such uncertainty, the ACA pursued the path of considering a range of different approaches to controlling health care costs ... Whether these policies by themselves can fully solve the long run health care cost problem in the United States is doubtful. They may, however, provide a first step towards controlling costs—and understanding what does and does not work to do so more broadly.” – Jonathan Gruber



As we can see, whether or not the ACA will reduce the health cost in general, and as such, reduce healthcare inflation remains up in the air. Current CBO estimates, however, expect the ASA to reduce healthcare spending for the federal government by $84 billion from 2012-2021.

Through the course of this paper, we analyzed the costs and benefits of the ACA for consumers, insurance companies, and the federal government. From an economic perspective, it appears that the ACA will hurt far less people than it will harm. However, there are a number of outliers and externalities that are presented as the ACA becomes implemented, such as higher premiums for those who already pay for health insurance, and the penalty tax imposed upon those who have no desire to pay for health insurance. While it is widely accepted that healthcare reform should be on the forefront of our political and economic agenda, the ACA will almost assuredly require revision and rewriting to close loopholes in the future. As healthcare inflation balloons out of control, we can only hope that the efforts of politicians and healthcare analysts can help lead us to a more unified and immersive healthcare system. As a nation, we stand on the crux of an economic crossroads. Do we follow in the footsteps of western European nations and nationalize healthcare for the good of the many? Or do we choose to support and stand behind our roots as the harbingers of the free market? For now, at least, we can take comfort in the fact that economically, we live in an exciting time.




















References


Jonathan Cohn (June 12, 2013)."You Call This Insurance?".The New Republic.

Essential Health Benefits – Glossary". Healthcare.gov. September 23, 2010..

"Patient Protection and Affordable Care Act of 2009: Health Insurance Exchanges". National Association of Insurance Commissioners. April 20, 2010..

Jonathan Cohn (June 13, 2012)."Obamacare, Good for the Economy.".The New Republic.

Gruber, Jonathan."The Impacts Of The Affordable Care Act: How Reasonable Are The Projections?"., revised published in: National Tax Journal, Vol. 64, 2011, p. 893-908

Jonathan Cohn (January 21, 2011)."The GOP's Trick Play".The New Republic.

Estimates for the Insurance Coverage Provisions of the Affordable Care Act Updated for the Recent Supreme Court Decision". CBO. July 24, 2012.

Jonathan Chait (June 5, 2013)."Is Obamacare a War on Bros?".New York.

^Krugman, Paul (January 31, 2010)."Krugman calls Senate health care bill similar to law in Massachusetts".PolitiFact.com. Tampa Bay Times. Retrieved August 29, 2012.
 
#10
Unless you have a technical skill, or are highly educated, middle-class jobs will be without of a persons reach. That's why there are so many unfilled jobs, but so many unemployed people.
Well, it's not just middle class jobs. Youth unemployment (lower working class job demographic) is also high. But regarding the "unfilled" jobs out there, wouldn't they be filled if adjustments were made on the "job supply" side? For example, higher wages or increased training?
 
#11
Well, it's not just middle class jobs. Youth unemployment (lower working class job demographic) is also high. But regarding the "unfilled" jobs out there, wouldn't they be filled if adjustments were made on the "job supply" side? For example, higher wages or increased training?
Companies can't justify that, though. Why do that when I could outsource such a job to a country that has more technological training ( india or japan )? Inhouse training is taking the way of the dodo as well. Companies can no longer justify spending money on extensive training for new employees. They figure that you should go to school and pay the costs of your education, and inhouse training should be minimal and to only get you used to specific procedures. Your collegiate training fills in the rest.

Youth unemployment is high, but higher if you didn't attend post-secondary school. Youth unemployment is lower if you have a technical degree. So there is a vast amount of evidence of asymmetry in the work force ( job searchers are looking for jobs that are not plentiful, job providers are providing jobs where the work force is not plentiful ). The issue is, it's easier to take a job that is below your skillset ( flipping burgers ) than it is to restructure your life back into training mode and obtain a technical degree. The government provides hefty subsidies to go back to school ( In grants alone this year I received 14k, and 8k in scholarships. That is more than enough to pay for my school tuition, books, and live well below the poverty level comfortably ;) ). Unfortunately, it's the people that have children relying on them that face the fewest options for a way out.
 
#12
Companies can't justify that, though. Why do that when I could outsource such a job to a country that has more technological training ( india or japan )?
So, why doesn't massive outsourcing factor into the economic analysis? Those jobs are missing income in the US in multiple ways (taxes, domestic demand, etc.)
 
#13
So, why doesn't massive outsourcing factor into the economic analysis? Those jobs are missing income in the US in multiple ways (taxes, domestic demand, etc.)
Well, they are and they aren't. Sure the labor is cheaper, but so are the products that are produced. This in effect lowers the cost of living. It also creates more positions for logistics and quality control. And the profits made by US firms still factors into our GNP and GDP. So if we're spending 14 dollars an hour on one IT guy, when we've just hired 7 of them for 2 dollars an hour in india, it's going to increase overall productivity. If we needed, say, 1400 an hour worth of IT guys to run our operation, the US didn't take a hit of 700 workers ( that we would be able to employ in India ), we took a hit of 100 workers ( 1400/14 ). But the ability to manage such an operation has consequently fallen ( think of it as job entropy ), so we need to employ more managers and telecom guys to keep that the business running smoothly, which could mean, say, 50 guys to manage the 700 new IT guys. In effect, business now jump up on a higher PPF, but spend less money doing it, while only losing 50 jobs domestically. Make sense?
 
#14
If you think of jobs like a normal good ( which they are ), and you think of outsourcing like a trade of normal goods ( which is it ), this makes sense intuitively. If you're able to produce 6 apples an hour, and I'm able to product 3 apples an hour, and we both consume 3 apples an hour, you're twice as better off as me. But if we also need to consume 3 oranges and hour, and I can produce 6 an hour and you can produce 3 an hour, then I'm better off than you. This means that to satiate our needs, we will need to spend 2 hours of work to satisfy our needs ( for you, you need to spend an hour making 6 apples to satiate your need for 3 apples this hour, and 3 apples in the next hour that you will produce the 3 oragnes ( and vice versa for me). However, if you and I agree to trade apples for oranges on a 3:3 scale, then we both only need to work one hour to satiate our needs, and the total affect on the economy is an increase in 3 apples and 3 oranges (6a+6o+6a+6o)-(3a+6o+3a+6o)=3a+6o . So we basically used comparative advantage to both be better off. This is the same with outsourcing.
 
#15
Sure the labor is cheaper, but so are the products that are produced.
Right, which also means less state (gov) sales tax revenue.
This in effect lowers the cost of living.
Depends on the product and how long it lasts.

And the profits made by US firms still factors into our GNP and GDP. So if we're spending 14 dollars an hour on one IT guy, when we've just hired 7 of them for 2 dollars an hour in india, it's going to increase overall productivity. If we needed, say, 1400 an hour worth of IT guys to run our operation, the US didn't take a hit of 700 workers ( that we would be able to employ in India ), we took a hit of 100 workers ( 1400/14 ). But the ability to manage such an operation has consequently fallen ( think of it as job entropy ), so we need to employ more managers and telecom guys to keep that the business running smoothly, which could mean, say, 50 guys to manage the 700 new IT guys. In effect, business now jump up on a higher PPF, but spend less money doing it, while only losing 50 jobs domestically. Make sense?
It makes sense for owners but not workers.
 
#16
If you think of jobs like a normal good ( which they are ), and you think of outsourcing like a trade of normal goods ( which is it ), this makes sense intuitively. If you're able to produce 6 apples an hour, and I'm able to product 3 apples an hour, and we both consume 3 apples an hour, you're twice as better off as me. But if we also need to consume 3 oranges and hour, and I can produce 6 an hour and you can produce 3 an hour, then I'm better off than you. This means that to satiate our needs, we will need to spend 2 hours of work to satisfy our needs ( for you, you need to spend an hour making 6 apples to satiate your need for 3 apples this hour, and 3 apples in the next hour that you will produce the 3 oragnes ( and vice versa for me). However, if you and I agree to trade apples for oranges on a 3:3 scale, then we both only need to work one hour to satiate our needs, and the total affect on the economy is an increase in 3 apples and 3 oranges (6a+6o+6a+6o)-(3a+6o+3a+6o)=3a+6o . So we basically used comparative advantage to both be better off. This is the same with outsourcing.
That would almost make sense (do we both NEED to consume 3 apples an hour, too?) in a hypothetical economy where the same people directly traded both their labor to make the products as well as the products themselves, and also owned the land/machinery/etc used for production. But in what's traditionally thought of as a "free market economy", labor is not "owned".
With outsourcing, the advantage is gained by relocation whenever feasible to areas on the globe with the fewest labor rights and the highest unemployment, serving as a race to the top for the owners of the enterprise, and an overall race to the bottom for workers.
 
#17
Right, which also means less state (gov) sales tax revenue
And is also offset by the increased quantity of consumed goods. When goods become cheaper, assuming they are income elastic and normal goods, more of them are consumed. Receiving sales tax revenues from a $10 mug or receiving sales tax revenues from 2 $5 mugs results in the exact same sale tax income. In our case, and in many recent studies, we receive more sales tax when goods are cheaper, as opposed to when they are more expensive. Cheaper goods provide incentives to consume rather than to save.

Depends on the product and how long it lasts.
Well, look at african countries. Wheat production is costly and risky. If they produced it domestically, the price of food would go up in the absence of other normal food goods. We would be misallocated resources to attempting to produce wheat, so the production quantities of other normal food items would drop as well. This increases the market-wide price of food to an upward trend. If they exploit comparative advantage ( which they do ), and consume US food products, then they can receive cheaper food, and allocated resources to more productive economic activities suited to their economic structure.



It makes sense for owners but not workers.
It makes sense for workers as well. American workers aren't begging and pleading for $2 an hour jobs with no vacation times, long hours, and little to no work-related injury protection. They want $14+ hour jobs with time off, 401ks, vacation and sick days, etc. Maybe if unemployed workers stopped demanding those things and were more willing to take on jobs with more skill required and get paid like shit, companies would have more incentive to hire domestically. You can't force a firm to choke down profits because of some mis-placed nationalistic view. Firms will do what is best for firms. If a country forces them to hire domestically, it makes more sense to use that money to relocate the entire firm into another country with more lax business laws, and export globally. Then you lose ALL the jobs created by that firm domestically, as well as ALL the profits that that firm produces from GNP and GDP.

The solution is simple; if you don't want a $60,000 camry, or a $4500 Iphone endorse outsourcing. When no one's able to afford those things, they don't sell anyways, destroying those jobs in the process.
 
#18
That would almost make sense (do we both NEED to consume 3 apples an hour, too?) in a hypothetical economy where the same people directly traded both their labor to make the products as well as the products themselves, and also owned the land/machinery/etc used for production. But in what's traditionally thought of as a "free market economy", labor is not "owned".
Labor is generally considered an asset that is owned by the firm, yes. Don't confuse the political and accounting view of labor with the economic view of labor. In economics, physical capital and labor are both employed ( owned and used ) by the firm.

With outsourcing, the advantage is gained by relocation whenever feasible to areas on the globe with the fewest labor rights and the highest unemployment, serving as a race to the top for the owners of the enterprise, and an overall race to the bottom for workers.
So, it's like I said: comparative advantage.

Comparative Advantage said:
comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another.
If labor can produce 1 unit of output for $2 in another country and can produce 1 unit of output for $14 in another country; I'm simply using comparative advantage to reduce my costs of production.

Labor is viewed by firms as an input, just like physical capital. They are considered normal goods to each other, and firms have a specific ratio of labor to capital that produces an optimal output conducive to the market optimal output ( where MC=AC ). If labor is viewed as a normal good like capital, it's within the firms best interests to find out where to get it cheapest, and provide the largest MPK.

If your view is one of morality, then I agree with you. However, we are discussing economics, and economics doesn't care too much about morality. It cares about what has the biggest outputs.
 
C

chuck.drake

#19
All the economic models you are talking about are ultimately unsustainable in any case. The current system will always result in growing human inequity and the rapid depletion of natural resources. You say economics don't care about morality, but we need economists exploring radical new models that value equity and the preservation of resources.
 
#20
All the economic models you are talking about are ultimately unsustainable in any case. The current system will always result in growing human inequity and the rapid depletion of natural resources. You say economics don't care about morality, but we need economists exploring radical new models that value equity and the preservation of resources.
Preservation of resources is an incoherent concept, though, and one outside the grasp on economics. If we want to change resource usage, you have to change how society chooses to value consumer goods. Why do you think gaming is becoming more popular and focused? No longer do you need to burn fossil fuels to drive to a movie, etc. If consumers began valuing virtual goods in the same manner that they do physical goods, consumption would decrease. But like I said, economics models how people use their resources when dealing with scarcity. It's up to the government and the people to realize and act on the scarcity, as most policies instituted by government have very little economic analysis weaved into them. Most of it is ' in the interest of national welfare ' or driven by market influences (lobbyists).
 
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