The Day the Economics Profession Lost Its Last Shred of Dignity

January 14, 2011. That's when Stanford economist John B. Taylor made the following arguments:

1. Higher government purchases, as a percent of GDP, are associated with higher rates of unemployment. Therefore: "There is no indication that lower government purchases increase unemployment; in fact we see the opposite..."
2. Higher levels of investment, as a percent of GDP, are associated with lower rates of unemployment. Therefore: "Encouraging the creation and expansion of businesses should be the focus on government efforts to reduce unemployment. The recent compromise agreement to prevent the increase in tax rates on small businesses and the move to lighten up on the anti-business sentiment coming out of Washington are two steps in the right direction."

And with that, I lost all respect for Taylor.  

It pains me to write those words. I've disagreed with his policy prescriptions over the past couple years, but never did I expect him to sink to the level of a second-rate undergraduate student.

He's a titan in macroeconomics. The Fed (approximately) follows the "Taylor rule," for goodness sake! And yet, here he is, making statistical mistakes that would flunk him out of introductory econometrics. Let's count the mistakes, shall we?

1. Correlation is not causation. Do higher government purchases cause higher unemployment, or does higher unemployment lead the government to increase its purchases? Well, we would expect the latter, even if we hadn't seen Taylor's data. Taylor insists that his analysis shows that "the correlation is not due to any reverse causation from high unemployment to more government purchases." Okay...so where's this analysis? If you're so sure, show us the numbers so we can verify!
2. Yo, professor, there's a third variable: GDP. I may not have tenure at Stanford, but I'm pretty sure that GDP decreased faster than government purchases in post-WWII recessions. In fact, government purchases tend to increase because more people need unemployment benefits and Medicaid. (They're called "automatic stabilizers." You might have heard of them in Econ 101.) So...higher rates of unemployment do cause higher government purchases as a percent of GDP.
3. Again, correlation is not causation. Do higher levels of investment cause lower rates of unemployment, or vice versa? What about a third factor that causes both? This data is absolutely useless in answering these questions.
4. Even if we grant that higher levels of investment cause lower rates of unemployment: Can someone tell me what evidence Taylor gives for the assumption that tax cuts for the top 2% of Americans and less regulation are the ticket to higher levels of investment? Again, Ben Bernanke doesn't follow the "Orlando rule" or anything, but just off the top of my head, firms will only invest if they expect to make a profit. And they only expect to make a profit if consumers will purchase their products. And consumers need growing incomes to purchase those products. So...this has what to do with tax cuts for the rich and less regulation? Gee, it sounds like the best way to increase investment is to give those people jobs or at least temporary money they can spend. But, gasp, that sounds suspiciously like the government's duty!

It's enough to make a serious economist weep.