Brad Delong Posts from January 2009 on Keynesian Stimulus, compiled by Eric Rasmusen, Feb. 1, 2009
In Which We Love Some But Not All Stimulus Spending Skeptics...
Arnold Kling feels lonely and unloved:
I'm feeling somewhat lonely these days. My understanding of
macroeconomics is closer to that of Paul Krugman, Mark Thoma, and Brad
DeLong than it is to that of Robert Barro, John Cochrane, or Eugene
Fama. And yet I am a stimulus skeptic...
It's fine to be a stimulus skeptic! But stimulus skeptics need to be
stimulus skeptics for reasons that are (a) theoretically coherent and
(b) empirically relevant. To be a stimulus skeptic because you fear
that the bill that emerges from congress will have a very low bang-
for-buck, or fear that the long-run drag from amortizing the extra
debt will cost us more than we gain from the short-run fiscal boost.
But it's not fine to be a stimulus skeptic for reasons that are
empirically irrelevant or theoretically incoherent. Specifically, you
"I am a stimulus skeptic because the savings-investment national
income equation guarantees that fiscal policy cannot boost employment
and production--not even if there are lots of unemployed resources in
the economy." The savings-investment equation is an accounting
identity: it has no implications whatsoever for whether fiscal policy
is effective or ineffective. None.
"I am a stimulus skeptic because the money multiplier and the
velocity of money are both fixed, so total nominal spending is a
constant times the government-created outside money stock of currency
and reserve deposits--except in the extraordinary case when banks or
households are pathologically sitting on cash." But in normal times
the money multiplier is definitely not a constant--it is interest
elastic (see Milton Friedman and Anna J. Schwartz, Monetary History of
the United States). And in normal times the velocity of money is not a
constant either--it is also interest elastic (see Milton Friedman,
ed., Studies in the Quantity Theory of Money).
The depressing thing is the number and credentials of the stimulus
skeptics who are making arguments that are either theoretically
incoherent or empirically irrelevant. The claim that the savings-
investment identity prohibited fiscal policy from having any impact
whatsoever was the infamous British "Treasury View" of the interwar
period, and was dealt with and rejected then--when Milton Friedman
writes about his framework for monetary analysis in the 1950s, 1960s,
and 1970s, he rejects the theoretical argument that fiscal policy must
be ineffective as strongly as Jim Tobin does. And he goes to great
pains to emphasize that the claim that the velocity of money is
constant in normal times is not true and is not part of his
monetarism. And nobody has ever argued that the money multiplier is a
constant. That fiscal policy can affect employment and output when the
economy has substantial unemployed resources was--I thought--well-
settled by the 1950s. Which is why it is depressing to see economists
like Fama, Lucas, Cochrane, and Mankiw saying "no."
And the truly depressing thing is that smart people like Neil
Sinhabababu look at this mishegas and, understandably, write:
EzraKlein Archive | The American Prospect: So I'm just Joe
Philosophy Professor watching Krugman & DeLong vs. the Chicago
Schoolmen about whether we need fiscal stimulus, with Nobel Prize
winning economists* on either side. And I'm thinking: How many fields
are there in which a big practical question pops up and the Nobel-
level guys are on opposite sides yelling at each other?... [I]t isn't
a question that should be sitting at the far cutting edge of research,
like how many dimensions your string theory needs to have. The raison
d'etre of the discipline is to deal with stuff like this.
I'm not saying that individual economists are sleeping on the job
-- there are legitimate reasons why this is difficult stuff to do. We
have a vanishingly small amount of historical data to work with, and
economists can't go into the lab, start depressions in twenty
Erlenmeyer flasks, and dump in different stimulus packages to see what
works. But that in itself is a reason to be wary of math-heavy,
evidence-light economic models and the pronouncements that they
produce. (Big philosophers famously disagree about all sorts of stuff.
But we have an excuse -- often when we all agree on something, it
stops being an area of philosophy...)
I had thought that the questions of whether the "Treasury View" was
correct, whether the money multiplier was a constant, and whether the
velocity of money was constant in normal times had been settled and
were no longer live parts of economics. But here we are...
Posted at 11:24 AM in Economics, Economics: Economists, Economics:
Fiscal Policy, Sorting: Front Page, Sorting: Pieces of the Occasion |
Permalink | Comments (21)
January 29, 2009
Any Lessons for the Stimulus from World War II?
Paul Krugman pounds his head against the wall:
Spending in wartime: One of the small compensating benefits of the
economic crisis is that people have suddenly realized that economic
history is relevant. Unfortunately, some of the attempts to use that
history are spectacularly off-base — such as the attempts by
conservative economists to use experience during World War II to argue
that the multiplier on government spending is low. I’ve written about
this here and here. But I thought a bit more data might be
instructive. You see, Robert Barro made much of the fact that private
spending actually went down during World War II — which he took as
evidence of “crowding out”. But what types of private spending fell,
[S]pending on new homes and cars before, during, and after the war
years. Both basically collapsed. Why? The answer is that (1) There
were draconian building restrictions in effect — in fact, the end of
those restrictions helped set off the postwar housing boom, and (2)
new cars weren’t being produced, because the factories were making
tanks instead (and if you did manage to acquire a car somehow,
gasoline was rationed).
Why anyone thinks that private spending during those years is a
model for what will happen as a result of fiscal stimulus now is
Posted at 12:52 PM in Economics, Economics: History, History, Sorting:
Front Page, Sorting: Pieces of the Occasion, Utter Stupidity |
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January 29, 2009
More Head-Wall Pounding...
The Sorrow and the Pity (wonkish): Eugene Fama, completely not getting it. Proposition 2 is wrong, because
savings is an endogenous variable, not a fixed quantity. This has become truly painful to watch.
Bailouts and Stimulus Plans - Addendum 1/28/09 - Fama/French Forum: Again, here is my argument in three
1. Bailouts and stimulus plans must be financed.
2. If the financing takes the form of additional government debt, the added debt displaces other uses of the
3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive
It is scary that nobody has pointed out to Fama the implications of his argument. For one thing, it means that
money printing cannot boost spending either--for a dollar bill is nothing if it is not a particular kind of
"additional government debt." And private-sector decisions to boost spending on high-tech or houses cannot boost
total spending either--because private investment spending must also be financed, and must also by Fama's logic
crowd out other expenditures.
Posted at 12:25 PM in Economics, Economics: Fiscal Policy, Sorting: Front Page, Sorting: Pieces of the Occasion |
DeLong Smackdown Watch (Slope-of-the-LM-Curve Edition)
A correspondent critiques my overexcited critique of John Cochrane:
I read your blog post today on John Cochrane’s new article, and I think you are misreading him.... Look at the
first paragraph in the section entitled “A monetary argument for fiscal stimulus.” In the end, John concedes
that, in principle, fiscal stimulus can help by, among other things, increasing the velocity of money (though
he doesn’t use that terminology). He only argues that it very unlikely to be done in such a way that it would
work, and that there are huge risks associated with doing it wrong.
He also disputes the notion that monetary policy can’t help when short-term interest rates are zero by
proposing that the Fed buy corporate debt and sell Treasuries.
I would be interested to see how you respond to his actual arguments, rather than the straw man argument that
he himself sets up and knocks down...
With respect, I still don't think you are disagreeing with him in this regard. "People pathologically sitting
on cash" is just another way of saying the velocity of money is lower than what it needs to be to have full
employment. What else could it possibly mean? If demand for cash and cash equivalents is abnormally high, then
money is going to be sitting idle in demand deposits and t-bills and not moving around in transactions...
The passage at issue is:
Cochrane: A monetary argument for fiscal stimulus, logically consistent but unpersuasive: My first fallacy was
“where does the money come from?” Well, suppose the Government could borrow money from people or banks who are
pathologically sitting on cash, but are willing to take Treasury debt instead. Suppose the government could
direct that money to people who are willing to keep spending it on consumption or lend it to companies who will
spend it on investment goods. Then overall demand for goods and services could increase, as overall demand for
money decreases. This is the argument for fiscal stimulus because “the banks are sitting on reserves and won’t
lend them out” or “liquidity trap.”
In this analysis, fiscal stimulus a roundabout way of avoiding monetary policy. If money demand increases
dramatically but money supply does not, we get a recession and deflation. If we want to hold two months of
purchases as money rather than one months’s worth, and if the government does not increase the money supply,
then the price of goods and services must fall until the money we do have covers two months of expenditure.
People try to get more money by spending less on goods and services, so until prices fall, we get a recession.
This is a common and sensible analysis of the early stages of the great depression. Demand for money
skyrocketed, but the Fed was unwilling or, under the Gold standard, unable, to increase supply.
This is not a convincing analysis of the present situation however...
I think it depends on how you interpret Cochrane's "pathologically:"
If you want to say that people or banks are "pathologically sitting on cash" most of the time, so that most of the
time an increase in the short safe nominal interest rate will increase the economy's inside money supply (without
any action by Federal Reserve) and also increase the economy's velocity of inside money, then my correspondent is
If you want to say that the state of things in which people are "pathologically sitting on cash" is unusual,
exceptional, and, indeed, pathological--defined as "extreme, excessive, and markedly abnormal"--than I am right.
There also is, I think, a failure to divide up the world in the same way. I distinguish between policies of:
Pure inflation--the government prints up a lot of money and spends it to expand the outside monetary base and
the total nominal value of outstanding assets to drive the price level up and induce a flight from nominal
assets to real commodities.
Monetary stimulus--the central bank buys short-term safe government bonds for cash.
Credit stimulus--the central bank or the finance ministry do other things to increase the capitalization or
otherwise improve the functioning of financial intermediaries or to reduce the amount or improve the
characteristics of the credit-market assets that the private sector must hold.
Fiscal policy--the government borrows and spends.
I think I know how to analyze (1), (2), and (4). I think we shouldn't do (1) (at least not yet). I think we have
done (2) and can't do any more of it and expect it to have any effect. I think we should do (3) and (4) in some
linear combination--but I have a hard time thinking about (3) because I am Bear of Little Brain.
Cochrane doesn't seem to cut the world up this way. He seems to believe, or perhaps to be very close to believing,
that anything that affects any of (a) the outside monetary base, (b) the money multiplier, or (c) the velocity of
inside money is "monetary policy"--in which case it is tautologically true that only monetary policy affects
spending, but I don't find that terribly useful.
Posted at 12:09 PM in Economics, Economics: Federal Reserve, Economics: Finance, Economics: Fiscal Policy, Sorting:
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What Are Chicago's Economists Thinking?
I am watching Eugene Fama, Robert Lucas, and now John Cochrane stagger around assuring everyone that fiscal policy
cannot boost employment and production--no matter how high the unemployment rate and how much unused capacity there
is--as a matter of "just accounting" that "does not need a complex argument about 'crowding out'":
John Cochrane: Most fiscal stimulus arguments suffer from three basic fallacies. First, if money is not going
to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar
that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of
increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus
spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories,
but fiscal stimulus can’t help us to build more of both. This is just accounting, and does not need a complex
argument about “crowding out”...
Cochrane is at least superior to the other two, in that he does concede that there is an (unlikely and
inapplicable) case in which fiscal policy might have some impact--if people are acting "pathologically":
[S]uppose... people or banks... are pathologically sitting on cash.... Suppose the government could direct that
money to people who are willing to keep spending it.... This is not a convincing analysis of the present
And I can barely believe my eyes.
Paul Krugman provide me with welcome assurance that I have not gone crazy:
A Dark Age of Macroeconomics: Brad DeLong is upset about the stuff coming out of Chicago these days — and
understandably so. First Eugene Fama, now John Cochrane, have made the claim that debt-financed government
spending necessarily crowds out an equal amount of private spending, even if the economy is depressed — and
they claim this not as an empirical result, not as the prediction of some model, but as the ineluctable
implication of an accounting identity. There has been a tendency, on the part of other economists, to try to
provide cover — to claim that Fama and Cochrane said something more sophisticated than they did. But if you
read the original essays, there’s no ambiguity — it’s pure Say’s Law, pure “Treasury view”, in each case....
What’s so mind-boggling about this is that it commits one of the most basic fallacies in economics —
interpreting an accounting identity as a behavioral relationship. Yes, savings have to equal investment, but
that’s not something that mystically takes place, it’s because any discrepancy between desired savings and
desired investment causes something to happen that brings the two in line. It’s like the fact that the capital
account and the current account of the balance of payment have to sum to zero: that’s true, but it does not
mean that an increase in capital inflows magically translates into a trade deficit, without anything else
changing (what John Williamson used to call the doctrine of immaculate transfer). A capital inflow produces a
trade deficit by causing the exchange rate to appreciate, the price level to rise, or some other change in the
real economy that affects trade flows.
Similarly, after a change in desired savings or investment something happens to make the accounting identity
hold. And if interest rates are fixed, what happens is that GDP changes to make S and I equal. That’s actually
the point of one of the ways multiplier analysis is often presented to freshmen.... [S]avings plus taxes equal
investment plus government spending, the accounting identity that both Fama and Cochrane think vitiates fiscal
policy — but it doesn’t. An increase in G doesn’t reduce I one for one, it increases GDP, which leads to higher
S and T.... [Y]ou don’t have to accept this model as a picture of how the world works. But you do have to
accept that it shows the fallacy of arguing that the savings-investment identity proves anything about the
effectiveness of fiscal policy.
So how is it possible that distinguished professors believe otherwise? The answer, I think, is that we’re
living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were
primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge
had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that
followed. And that’s what seems to have happened to macroeconomics in much of the economics profession. The
knowledge that S=I doesn’t imply the Treasury view — the general understanding that macroeconomics is more than
supply and demand plus the quantity equation — somehow got lost in much of the profession. I’m tempted to go on
and say something about being overrun by barbarians in the grip of an obscurantist faith, but I guess I won’t.
Oh wait, I guess I just did.
And at least some of the lurkers agree with me in email:
[H]ow spectacularly wrong they are... not in a clever or subtle way, but in a "let me put this on an Econ 1
final and ask freshmen to explain what's wrong here" sort of way.... You and I are out for a stroll, with no
plans to buy anything. We walk by a barbershop, and I notice that there's no wait for a haircut. Having no
money, I borrow some from you, write you an IOU, and go get my haircut, during which time no other customers
have to wait. According to Cochrane, it's not merely the case that this couldn't happen in some models (models
where the barber, having no customers, cuts prices -- or goes home to mow the lawn -- or models where you don't
carry idle cash around), but that as a matter of accounting, this can't happen...
If I thought I had found an error (or a crucial unstated assumption that no one had noticed) in the work of
Keynes, Hicks, Samuelson, Modigliani, Patinkin, Metzler, Tobin, ... who were not only spectacularly smart but
also in many cases (Patinkin, Metzler, Tobin, ...) thought really hard about the asset market... my reaction
would be, "I better figure out what my mistake is," not "I better tell the world about this right away"...
Milton Friedman disagreed with James Tobin about the relative effectiveness of monetary and fiscal policy in
"normal" times. I agree with Friedman (and disagree with Tobin) about the relative effectiveness of monetary and
fiscal policy in "normal" times. But Friedman thought Tobin was worth debating--Friedman did not have the stupids
to claim that Tobin was completely wrong as a matter of "just accounting."
Posted at 08:17 AM in Economics, Economics: Federal Reserve, Economics: Finance, Economics: Fiscal Policy, Sorting:
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A Far Superior Classification of Stimulus Critiques from Menzie Chinn
Econbrowser: Five Reasons Why Fiscal Policy Might Be Completely Ineffective: A Textbook Exposition.
Posted at 07:35 PM in Economics, Economics: Fiscal Policy, Sorting: Front Page, Sorting: Pieces of the Occasion |
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Time to Bang My Head Against the Wall Some More (Pre-Elementary Monetary Economics Department)
Oh boy. John Cochrane does not know something that David Hume did--that the velocity of monetary circulation is an
economic variable rather than a technological constant. Cochrane:
Fiscal Fallacies: First, if money is not going to be printed, it has to come from somewhere. If the government
borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to
spend on new investment. Every dollar of increased government spending must correspond to one less dollar of
private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private
spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both.
This is just accounting, and does not need a complex argument about “crowding out”...
Let us take this slowly.
Suppose that we have four agents: Alice, Beverly, Carol, and Deborah.
Suppose that Beverly has $500 in cash that she owes Carol, due in two months. Suppose that Alice and Carol are both
unemployed and idle.
In one scenario in two months Beverly goes to Carol and pays her the $500. End of story.
In a second scenario Beverly says to Alice: "I have a house. Why don't you build a deck--I will pay you $500 after
the work is done. Here is the contract." Alice takes the contract and goes to Carol. She shows the contract to
Carol and says: "See. I will be good for the debt. Cook me meals so I will have the strength to build the deck--
here's another contract in which I promise to pay you $500 within 90 days if you cook for me." Carol agrees.
Two months pass. Carol cooks and feeds Alice. Alice goes and builds the deck.
Alice then asks Beverly for payment. Beverly says: "Wait a minute." She goes to Carol and says: "Here is the the
$500 cash I owe you." Beverly pays the money to Carol. Beverly then says: "But now could I borrow the cash back by
offering you a long-term mortgage at an attractive interest rate secured with an interest in my newly more-valuable
house?" Carol says: "Sure." Beverly files an amended deed showing Carol's mortgage lien with the town office. Carol
gives Beverly back the $500. Beverly then goes to Alice and pays her the $500. Alice then goes to Carol and pays
her the $500.
The net result? (a) Alice who would otherwise have been idle has been employed--has traded her labor for meals. (b)
Carol who would otherwise have been idle has been employed--has traded her labor for a secured lien on Beverly's
house. (c) Beverly has taken out a mortgage on her house and in exchange has gotten a deck built. (d) Carol has the
$500 cash that Beverly owed her in the first place.
Alice has more income and consumption expenditure than if she hadn't taken Beverly's job offer. Carol has more
income and saving than if she hadn't cooked for Alice and then invested her earnings with Beverly. Beverly has an
extra capital asset (the deck) and an extra financial liability (the mortgage) than if she had never offered to
A deck has gotten built. Meals have been cooked and eaten. Two women have been employed. And all this has happened
without printing any extra money.
John Cochrane would say that this is impossible. John Cochrane would say:
[I]f money is not going to be printed, it has to come from somewhere. If Beverly borrows a dollar from Carol,
that is a dollar that Carol does not spend, or does not lend to Deborah to spend on new investment. Every
dollar of increased Beverly spending must correspond to one less dollar of Carol or Deborah spending. Alice's
job created by Beverly spending is offset by a job lost from the decline in Carol or Deborah spending. We can
build decks instead of fountains, but Beverly stimulus can’t help us to build more of both. This is just
accounting, and does not need a complex argument about “crowding out”...
John Cochrane is wrong.
You sometimes see this mistake in freshmen students in Economics 1, students who do not fully understand either the
circular flow of economic activity or what a credit economy is. They think--like Cochrane--that the flow of
spending must be constant unless somebody "prints money" because, you see, you need "money" in order to buy things.
The premise is true--you do need "money" to buy things--but the conclusion is false: the flow of spending is not
necessarily constant. In the world in which Beverly does not hire Alice but instead pays the $500 directly to
Carol, that $500 turns over only once--its velocity of circulation is equal to one. In the world in which Beverly
does hire Alice, the velocity of circulation of the $500 is four--it goes from Beverly to Carol, from Carol to
Beverly, from Beverly to Alice, and from Alice to Carol.
Cochrane's mistake--an elementary, freshman mistake--is because he has not thought enough about how a credit
economy works to recognize that the velocity of circulation can be an economic variable and is not necessarily a
technological constant. And as the velocity of circulation varies, the amount of the flow of spending varies as
well: it is now longer the case that if Beverly borrows a dollar from Carol that is a dollar that Carol does not
Milton Friedman knew this. Irving Fisher knew this. Simon Newcomb knew this. David Hume knew this. John Cochrane
does not know this: does not know that the velocity of circulation is an economic variable rather than a
I do want to pound my head against the wall.
I do not know what else to do...
Posted at 03:37 PM in Economics, Economics: Federal Reserve, Economics: Finance, Sorting: Front Page, Sorting:
Pieces of the Occasion | Permalink | Comments (50) | TrackBack (0)
Best Anti-Stimulus Argument: from Kevin Murphy
Matthew Yglesias agrees that Kevin Murphy gives the:
Best Anti-Stimulus Argument I’ve Seen: Kevin Murphy’s slides here. I think he overstates the deadweight loss
effect and is working with the wrong conception of “efficiency” for these purposes when he claims that
government is inefficient, so the odds of a stimulus being successful therefore aren’t as bad as he indicates.
And this doesn’t change the fact that I haven’t heard any better ideas than doing a big stimulus. But this is a
sobering reminder that a big stimulus doesn’t guarantee success—very hard work needs to be done on making sure
that stimulus funds target genuinely idle resources rather than diverting non-idle resources while leaving the
idle ones as idle as ever.
Here is Kevin:
Evaluating the Fiscal Stimulus
Kevin M. Murphy
January 16, 2009
A Framework for Thinking about the Stimulus Package
* Let G = increase in government spending
* 1-a= value of a dollar of government spending (a measures the inefficiency of government)
* Let f equal the fraction of the output produced using “idle” resources
* Let ? be the relative value of “idle” resources
* Let d be the deadweight cost per dollar of revenue from the taxation required to pay for the spending
When Will the Stimulus Add Value?
The net gain is the value of the output produced less the costs of the inputs and the deadweight loss
In terms of the previous notation we have: Net Gain = (1-a)G –[(1-f)G + ?fG] –dG
* Net gain = (f(1-?) –a–d)G
* A positive net gain requires that: f(1-?) > a+d
* Difference of opinion comes from different assumptions about f, ?, a, and d
My View * a likely to be large * Government in general is inefficient * The need to act quickly will make it
more inefficient * The desire to spend a lot in a short period of time will make it more inefficient * Trying
to be both stimulus and investment will make it even more inefficient * 1-f likely to be positive and may be
large * With a large fraction of resources employed (roughly 93%) much will be drawn from other activities
rather than “idle” resources * Ricardian equivalence implies that people will save to pay for future taxes
reducing private spending * ? is non-zero and likely to be substantial * People place positive value on their
time * Unemployed resources produce value through relocation (e.g. mobility & job search) * d is likely to be
significant * Wide range of estimates of d * Estimates based on the analysis of taxable income imply d˜0.8 *
With these parameters the stimulus package is likely to be a bad idea
As I read it, Kevin thinks a = 1/2, f = 1/2, ? = 1/2, d = 0.8, and gets 0.25 > 1.3. I would say that a = 0
(increasing income inequality and starvation of the non-health non-military public sector over the past generation
have left a bunch of low hanging fruit), f = 1.5 (there are multipliers out there, and markets work if there is
sufficient demand: as long as there are idle resources people will use them first as long as demand is available),
? = 1/5 (the cyclically unemployed are not having much fun), and d = 1/3. So I get 1.2 > 0.33.
More interesting, I think, is that there is an unemployment rate at which Kevin Murphy's priors would switch and he
would become a stimulus advocate. What is it?
Posted at 11:40 AM in Economics, Economics: Economists, Economics: Fiscal Policy, Political Economy, Political
Economy: Social Democracy, Sorting: Front Page, Sorting: Pieces of the Occasion | Permalink | Comments (25) |
Department of "Huh?"
Will Wilkinson writes:
Crowding Out: If you think markets tend to work better than government in giving people what they want and
need, then you’ll worry about government spending crowding out private spending. If you think government works
better than markets in giving people what they want and need, then you’ll want government spending to crowd out
private spending. I agree with Arnold Kling that maybe this helps explain why positions on the stimulus debate
break so cleanly (and damningly for the scientific pretensions of macroeconomics) along partisan lines. Here’s
On the stimulus proposal, the division is almost entirely left-right. I cannot think of a single economist
on the Left who is skeptical, and I cannot think of a single economist on the Right who is a supporter...
What is Martin Feldstein? Chopped liver?
Posted at 11:07 AM in Economics, Economics: Fiscal Policy, Sorting: Front Page, Sorting: Pieces of the Occasion |
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Chicago Has Little to Say...
A correspondent writes:
http://gsbmedia.chicagogsb.edu/GSBMediaSite/Viewer/?peid=439a24a984fa449a8833412955afac45 I found this U. Chicago
Panel Discussion on Mankiw's blog. Lucas, as I hear him, advocates the Treasury View without reservation. Fiscal
policy can have no real effect. Huizinga claims that all macro models predict an increase in G must reduce national
saving, a borderline example of the same erroneous reasoning behind the Treasury View. (ignores IS-LM models in
liquidity trap with accelerator effects on investment, but you know that.)
I actually thought Murphy's talk was sensible, although mainly wrong. Wish the equations were visible...
Huizinga simply seems confused. At a minimum, you need (a) business investment to not be a function of current
capacity utilization, and (b) government-owned capital to not be productive for his conclusions about national
saving to go through. My guess is that the Obama stimulus package will be a very small minus for national saving,
but I cannot see how the net effect will be large enough to be a reason for people to be either for or against it.
Lucas appears to be worse than confused. If government decisions to spend do not affect production, then private
decisions to spend do not affect production either--the same crowding-out argument applies. If this is the case,
then Lucas should renounce his Nobel Memorial Prize. It was given for his analysis of how monetary policy did and
did not lead to changes in private spending decisions that boosted or reduced output. Which--according to the
Treasury View--does not happen.
Murphy's I have not yet watched...
I am struck, once again, by a big gap between things like this and the stories told of what Stigler and Friedman
were like in their prime...
Posted at 01:05 PM in Economics, Economics: Federal Reserve, Economics: Fiscal Policy, Economics: Macro | Permalink
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of the Occasion | Permalink | Comments (6) | TrackBack (0)
Paul Krugman on Robert Barro
Paul Krugman piles on:
War and non-remembrance: As I’ve already pointed out,the prospect of a Keynesian stimulus is having a weird
effect on conservative economists, as first-rate economists keep making truly boneheaded arguments against the
effort. The latest entry: Robert Barro argues that the multiplier on government spending is low because real
GDP during World War II rose by less than military spending.
Actually, I’ve already taken that one on. But just to say it again: there was a war on. Consumer goods were
rationed; people were urged to restrain their spending to make resources available for the war effort. Oh, and the
economy was at full employment — and then some. Rosie the Riveter, anyone?
I can’t quite imagine the mindset that leads someone to forget all this, and think that you can use World War II to
estimate the multiplier that might prevail in an underemployed, rationing-free economy.
Posted at 01:55 PM in Economics, Economics: Fiscal Policy, Sorting: Front Page, Sorting: Pieces of the Occasion |
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January 22, 2009
Matthew Yglesias vs. Robert Barro
One of these people is a tenured university professor. The other is a juicebox-drinking basement-dwelling bathrobe-
Robert Barro writes:
Multipliers and Diminishing Returns: What do the data show about multipliers?... [T]he best evidence comes from
large changes in military purchases.... The usual Keynesian view is that the World War II fiscal expansion
provided the stimulus that finally got us out of the Great Depression. Thus, I think that most macroeconomists
would regard this case as a fair one for seeing whether a large multiplier ever exists. World War II raised
U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of
real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the
multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from
military purchases. The main declines were in private investment, nonmilitary parts of government purchases,
and net exports — personal consumer expenditure changed little. Wartime production siphoned off resources from
other economic uses — there was a dampener, rather than a multiplier...
Matthew Yglesias responds:
I think this is running together two separate issues. One is “whether a large multiplier ever exists” and one
is whether such multipliers suffer from diminishing returns. World War II spending was enormous relative to
GDP. Wartime spending on that kind of scale goes way beyond the conversations we’re having right now about
fiscal stimulus—the equivalent today would be something like a $5.2 trillion package rather than the $800
billion or so we’re talking about. And to get spending up to that level the government had to resort to quasi-
forced savings (”war bonds”), rationing, etc.--deliberate efforts to direct production away from where demand
was highest and toward the national objective of military production. The 0.8 multiplier is probably the result
of diminishing returns. The question is whether you got a decent multiplier out of the first 5-10 percent of
GDP you spend on stimulus. It shouldn’t surprise us if it turns out that defense spending eventually got
somewhat higher than would be economically optimal in the middle of the largest war in history.
Posted at 12:18 PM in Economics, Economics: Fiscal Policy, Economics: History, Sorting: Front Page, Sorting: Pieces
of the Occasion | Permalink | Comments (15) | TrackBack (0)
Will Gary Becker Please Return from the Gamma Quadrant?
Ummm... Gary... Please phone Reality on the white courtesy phone.
Gary Becker wonders:
The Becker-Posner Blog: On the Obama Stimulus Plan-Becker: there appears to have been a huge conversion of
economists toward Keynesian deficit spenders, but the evidence that produced such a "conversion" is not
apparent (although maybe most economists were closet Keynesians all along). This is a serious recession, but
Romer and Bernstein project a peak unemployment rate without the stimulus of about 9%. The 1981-82 recession
had a peak unemployment rate of about 10.5%, but there was no apparent major "conversion" of economists at that
time. What is so different about the present recession compared to that one, and to other recessions since
then, that would greatly raise the estimated stimulating effects of government spending on various types of
goods and services?..
The difference between now and 1982 was that back in 1982 the interest rate on Treasury bills was 13.68%--there was
a lot of room for the Federal Reserve to cut interest rates and so reduce unemployment via monetary policy. Today
the interest rate on Treasury bills is 0.03%--there is no room for the Federal Reserve to cut interest rates, and
so monetary policy is reduced to untried "quantitative easing" experiments.
The fact that monetary policy has shot its bolt and has no more room for action is what has driven a lot of people
like me who think that monetary policy is a much better stabilization policy tool to endorse the Obama fiscal boost
The fact that Gary Becker does not know that monetary policy has shot its bolt makes me think that the state of
economics at the University of Chicago is worse than I expected--but I already knew that, or rather I had thought I
already knew that.
Posted at 09:02 AM in Economics, Sorting: Front Page, Sorting: Pieces of the Occasion, Utter Stupidity | Permalink
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January 18, 2009
J. Bradford DeLong (2009), "The Modern Revival of the 'Treasury View'": January 18, 2009 DRAFT
to .pdf of J. Bradford DeLong (2009), "The Modern Revival of the 'Treasury View'": January 18, 2009 DRAFT
Robert Waldmann: Economic Theory as a Subbranch of Mathematics
Robert Waldmann winds up and asks a question: Hoisted from Comments:
Grasping Reality: Fama's Fallacy V: Are There Ever Any Wrong Answers in Economics?: "Economic science" is a
phrase like "military intelligence." Out of respect for my fellow economists and the DIA I won't name that
class of phrases. However, "economic theory" is a sub branch of mathematics. Within economic theory there are
defintely false statements such as those made by Mankiw and Fama.
I'm not surprised that Fama is making a fool of himself. He has made similarly nonsensical arguments in his own
field of expertise. He has been a tenured head of a school of thought for a long time, and has probably
forgotten what it was like to make arguments which weren't accorded respect just because he made them.
I don't know what Mankiw thinks he's doing. For one thing, he knows you and cannot hope that you will let the
matter drop. I can only infer that he knows much more about the sociology of economists than I do and
understands that, to be a mainstream economist in good standing, he has to take a hit for the team and claim
not to have noticed Fama's howler.
To me the odd thing is the extent to which the economics profession can hide our embarrassing secrets. Not
wanting to get Harvard graduates in trouble, I'd be inclined to take a poll of the general public to find out
how many people understand that Nobel prizes have been awarded for working out detailed implications of the
efficient markets hypothesis, for stating the rational expectations hypothesis (and not to Cournot or even Nash
but to Lucas and if you doubt it check the citation) or uhm to Ed Prescott.
Sauce for the goose is sauce for the gander, and, I note, that you claimed on this blog to think it was
reasonable to award the Noble prize to Prescott and elsewhere described an argument which basically quoted
something written under his name as failing the Turing test.
If I understand your argument, it is one I cannot refute. Yes, the Nobel Prize winners are the public authoritative
face of our profession. So, yes, I think I have to change my mind--and concur with you that the Swedish Academy
needs to pick Nobel Prize winners who are now wise as well as who once were very, very clever.
Posted at 11:34 AM in Economics, Economics: Economists, Economics: Macro, Sorting: Front Page, Sorting: Pieces of
the Occasion | Permalink | Comments (18) | TrackBack (0)
Fama's Fallacy V: Are There Ever Any Wrong Answers in Economics?
Fama's Fallacy V: Are There Ever Any Wrong Answers in Economics?
Montagu Norman here, back from my grave once again. This time it is Greg Mankiw whose words have summoned me...
One thing that used to give me nightmares--and that provoked several of my nervous breakdowns--was how you could
never get any economist (except for John Maynard Keynes) to take a definite position. They were always "on the one
hand--on the other hand." This was what led Harry Truman in later days to wish for a one-handed economist, a wish
that has never been fulfilled--there is in fact a picture of Barack Obama's economic advisor Christina Duckworth
Romer in Time (or is it Newsweek?) showing her with four hands...
The "on the one hand--on the other hand" nature of discourse raises the question of whether in economics--a
"science" where there is enormous intellectual and ideological and political disagreement about how the world
works--there can ever be any wrong answers?. I believe that there can be wrong answers in economics, because
examinations in economics tend to take a particular form: instead of asking (i) "do expansionary fiscal policies
increase output and employment?" we ask (ii) "in models where there are idle resources and high unemployment, do
expansionary fiscal policies increase output and employment?" (ii) is a question about a particular class of models
of the economy, and so has a definite right answer--"yes, in that class of models they do"--and a definite wrong
answer--"no, in that class of models they don't."
Eugene Fama claimed that "when there are idle resources--unemployment" expansionary fiscal policies had no effect
in models in which the NIPA savings-investment identity:
investment = (private savings) - (government deficit)
Now the NIPA savings-investment identity holds in all models--it is, after all, an identity, true by definition and
construction. And every single model that has been built in which there is a possibility of high unemployment and
idle resources is a model in which fiscal policy works because increases in government spending lead to unexpected
declines in inventories and unexpected declines in inventories lead to firms to expand production, which leads to
increases in income and saving.
I would, therefore, say that Fama's claim is "wrong". Not only does it not hold in all models in the class, it does
not hold in any models in the class.
Greg Mankiw disagrees:
Greg Mankiw's Blog: Fama's arguments make sense in the context of the classical model... presented in Chapter 3
of my intermediate macro textbook.... I would go on to the Keynesian model.... But whether one leaves the
classical model behind to embrace the Keynesian model is a judgment call...
Mankiw thinks that Fama is not wrong but is, rather, making a "judgment call."
But Mankiw writes in his chapter 3 that the classical model "assume[s] that the labor force is fully employed." And
so Greg gets himself into Cretan Liars' Paradox territory here: Fama says that there is high unemployment and idle
resources, while Mankiw says that Fama is not wrong because he makes sense as long as the labor force is fully
employed and there are no idle resources.
Is Mankiw's answer here a "wrong" answer, or is he too making a "judgment call"? I seek an empirical test. I seek a
Harvard undergraduate to take Greg Mankiw's course this spring, to write the following in an appropriate place:
the classical model of chapter 3 shows us that expansionary fiscal policies have no effect on output even where
there are idle resources--unemployment.
and to report back on the reaction of the course instructors.
Posted at 12:12 PM in Economics, Economics: Macro, Sorting: Front Page, Sorting: Pieces of the Occasion | Permalink
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Fama's Fallacy IV: The Decline of Chicago
Note to Self: How to make the "crowding out" argument the intellectually coherent way.
Milton Friedman (1972), "Comment on the Critics," Journal of Political Economy 80:5 (September-October), pp. 914-5
I do not share the widespread view that a tax increase which is not matched by higher government spending will
necessarily have a strong braking effect on the economy.
True, higher taxes would leave taxpayers less to spend. But this is only part of the story. If government
spending were unchanged, more of it would now be financed by the higher taxes, and the government would have to
borrow less. The individuals, banks, corporations or other lenders from whom the government would have borrowed
now have more left to spend or to lend-and this extra amount is precisely equal to the reduction in the amount
available to them and others as taxpayers. If they spend it themselves, this directly offsets any reduction in
spending by taxpayers. If they lend it to business enterprises or private individuals--as they can by accepting
a lower interest rate for the loans the resulting increase in business investment, expenditures on residential
building and so on indirectly offsets any reduction in spending by taxpayers.
To find any net effect on private spending, one must look farther beneath the surface. Lower interest rates
make it less expensive for people to hold cash. Hence, some of the funds not borrowed by the Federal government
may be added to idle cash balances rather than spent or loaned. In addition, it takes time for borrowers and
lenders to adjust to reduced government borrowing. However, any net decrease in spending from these sources is
certain to be temporary and likely to be minor.
To have a significant impact on the economy, a tax increase must somehow affect monetary policy--the quantity
of money and its rate of growth. (Newsweek, January 23, 1967, p. 86)....
Why "certain to be temporary"? Because the leftward shift in the IS curve is a once-for-all shift.... Put in
monetarist terms, the lowered interest rate resulting from the federal government's absorbing a smaller share
of annual savings will reduce velocity; the transition to the lower velocity reduces spending for a given money
Why "likely to be minor"? Because the monetarist view is that "saving" and "investment" have to be interpreted
much more broadly... that the categories of spending affected by changes in interest rates are far broader than
the business capital formation, housing construction, and inventory accumulation to which the neo- Keynesians
tend to restrict "investment." Hence, even a fairly substantial tax increase will produce only a minor shift in
the IS curve....
Of course, the terms "temporary" and "minor" are highly imprecise. We get closer to a rigorous statement by
comparing the changes resulting from a reduced or increased deficit without any change in monetary growth with
those that result when a change in the deficit is matched by a dollar-for-dollar change in monetary growth....
[A] deficit financed by borrowing... [is] a once-for-all shift to the right in the IS curve, a higher interest
rate, a higher velocity, and a higher level of spending for a given monetary growth path.... [F]inancing the
deficit by creating money... shifts the LM curve to the right.... But this is not a once-for-all shift. So long
as the deficit continues, and continues to be financed by creating money, the nominal money stock continues to
grow and the LM curve (at initial prices) continues to move to the right. Is there any doubt that this effect
must swamp the effect of the once-for-all shift of the IS curve?...
We may put this point differently. Assume a one-year increase in the deficit, with the budget then returning to
its initial position. If this is financed by borrowing from the public with no change in monetary growth, then,
in the most rigid Keynesian system, the IS curve moves to the right and then back again; real and nominal
income rise for one year, then return to their initial values. If the one-year increase in the deficit is
financed by creating money, the LM curve moves to the right as well, and stays there after the IS curve returns
to its initial position. If prices remain constant, real and nominal income stay at a higher level
indefinitely. If, as is more reasonable, prices ultimately rise, real income may return to its initial level,
but nominal income will stay at a higher level indefinitely. Surely, to paraphrase a remark of Tobin's in
another connection, the monetary effect is "alchemy of a much deeper significance" than the fiscal effect...
For Friedman, the NIPA savings-investment identity is the prelude to the analysis: the meat of the analysis
involves going deeper by:
* arguing that savings and income levels will adjust so that the economy will quickly move to a point at which
unwanted inventory accumulation is zero (that's the "IS curve").
* analyzing the combination of possible values for interest rates and output levels at which unwanted
accumulation is zero (that's the shape and position of the "IS curve").
* assessing how the changing financial asset supplies and demands in the economy pick out a particular point on
the IS curve (that's the "LM curve").
For Fama, the NIPA savings-investment identity is the completion of the analysis--hence he gets driven to the
conclusion that not just fiscal policy via the government deficit but monetary policy via open market operations
has no effect on employment and output as well.
This makes me think I should finish writing up one of the talks that I gave in Singapore--the point of which was
that Chicago economists today are profoundly ignorant of what the Chicago School of economics--the school of
Friedman and Stigler--believes.
Posted at 11:27 AM in Economics, Economics: Economists, Economics: History, Economics: Macro, History, Sorting:
Front Page, Sorting: Pieces of the Occasion | Permalink | Comments (7) | TrackBack (0)
January 14, 2009
Fama's Fallacy, Take III
Greg Mankiw writes:
Fama on Fiscal Stimulus: Eugene Fama is a stimulus skeptic: In fact, he is even more skeptical than I am. I am
willing to concede that many Keynesian effects work in the short run, although I prefer monetary policy to
fiscal policy and, within fiscal policy, I prefer the use of tax instruments to government spending as a tool
for short-run demand management. By contrast, I read Fama's article as a largely wholesale endorsement of the
classical model with complete crowding out.
No, Greg. It's not an endorsement of any model. It's just a mistake. Fama mistakes the NIPA savings-investment
accounting identity for a behavioral relationship that constrains the behavior of investment: when the government
deficit goes up, Fama says, private investment must go down by the same amount.
When the government deficit goes up, private savings could go up by more--and private investment could increase.
Private savings could go up by less--and private investment would fall by less than the rise in the government
deficit. Private savings could remain unchanged. Or private savings could fall. Determining which of these is most
likely to happen would require a model of the economy of some sort--and Fama does not have one: all he has is an
accounting identity that he does not understand.
Posted at 10:46 PM in Economics, Economics: Macro, Sorting: Front Page, Sorting: Pieces of the Occasion | Permalink
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Fama's Fallacy II: Predecessors
Eugene Fama's predecessors in error. The "Treasury View." From G.C. Peden (2004), Keynes and His Critics, p. 80:
F.W. Leith-Ross to Sir Richard Hopkins and P.J. Grigg, 3 April 1929:
Before the government can give increased employment it must obtain resources.... Unless the government is
prepared to... bring about an inflation... [it] can only obtain [resources] by taxation or borrowing.... The
proposal that we are examining is that all the money required is to be borrowed.... When the Government
borrows, it enters the money market as a competitor with all other enterprises.... The resources from which the
government must draw... are the savings of the people.... But it is precisely on these that industry relies
on.... The competition of the Government with private traders by means of large Government loans would not
(apart from inflation) increase the resources available for the employment of labour. It would only mean that a
portion of these resources would be directed by the Government instead of being directed by private persons...
Fama, actually, is much worse than the British Treasury economists of the 1920s. They acknowledged that monetary
policy could affect the level of employment--could do more than shift resources from one use to another. Fama's
argument based on his misinterpretation of the NIPA savings-investment identity has the implication that monetary
policy cannot affect the unemployment rate either.
See R.G. Hawtrey (1925), "Public Expenditure and the Demand for Labour," Economica 5, pp. 38-48.
Posted at 10:31 PM in Economics, Economics: History, Economics: Macro, History, Sorting: Front Page, Sorting:
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Fama's Fallacy, Take I: Eugene Fama Rederives the "Treasury View"
A Guestpost from Montagu Norman, former Governor of the Bank of England:
Back in the 1920s and 1930s--in the days that overly-clever bisexual academic dilettante John Maynard Keynes was
trying to persuade us that if only we got the government to spend more money the unemployment rate might go down--
by far the silliest argument against his position was the one put forward by the staff of the Chancellor of the
Exchequer: the so-called "Treasury View."
The Treasury View was that nothing could boost employment: not government spending, not tax cuts, not private
business decisions to expand their capacity, not irrational exuberance on the part of entrepreneurs--for the level
of output was what it was and the unemployment rate was what it was and no fiscal policies or private investment
decisions could change it, for all they could do was move resources from one use to another without affecting the
total flow of economic activity.
Back on Christmas Eve Paul Krugman whacked Caroline Baum of Bloomberg on the nose for rediscovering the Treasury
View. Now Eugene Fama of the University of Chicago has rederived it from scratch (apparently without knowing
anything of its history), claiming that the savings-investment national income identity proves that fiscal policy
cannot have any effect on output and employment.
This is a howler of such magnitude that it has pulled me from my grave to speak--because we went over and over this
in the 1920s starting with R.G. Hawtrey (1925), "Public Expenditure and the Demand for Labour," Economica 5, pp.
38-48, and with F.W. Leith-Ross's various Treasury memos to P.J. Grigg, and thrashed this out to a conclusion that
Fama appears not to know. It is very strange: the argument Fama wants to make--that government deficits completely
crowd out private investment so that fiscal policy has no effect on output or employment--is, depending on
circumstances, sometimes true and usually false, depending on circumstances. But the premise from which Fama
attempts to derive complete crowding-out is the savings-investment accounting identity in the National Income and
Product Accounts--and an accounting identity is something that must be true by construction, no matter what. The
fact that savings equals investment in the NIPA is logically independent of whether the complete crowding-out
doctrine is true or false.
Here is Fama:
Bailouts and Stimulus Plans: There is an identity in macroeconomics... private investment [PI] must equal the
sum of private savings [PS], corporate savings (retained earnings) [CS], and government savings [GS]....
(1) PI = PS + CS + GS....
The problem is simple: bailouts and stimulus plans are funded by issuing more government debt.... The added
debt absorbs savings that would otherwise go to private investment.... [S]timulus plans do not add to current
resources in use. They just move resources from one use to another.... I come back to these fundamental points
several times below....
The Sad Logic of a Fiscal Stimulus
In a "fiscal stimulus," the government borrows and spends the money on investment projects or gives it away as
transfer payments to people or states. The hope is that government spending will put people to work....
Unfortunately, there is a fly in the ointment.... [G]overnment infrastructure investments must be financed --
more government debt. The new government debt absorbs private and corporate savings, which means private
investment goes down by the same amount....
Suppose the stimulus plan takes the form of lower taxes... we can't get something for nothing this way
either... lower tax receipts must be financed dollar for dollar by more government borrowing. The government
gives with one hand but takes them back with the other, with no net effect on current incomes...
Fama's reasoning is that fiscal policies don't change private saving, but fiscal policies do change the government
deficit, thus investment must change in an amount equal and opposite to the change in the government deficit.
Fama's reasoning is dead wrong. Fama's reasoning is dead wrong for an elementary reason. The accounting identity
that savings are equal to investment is true only under a particular definition of investment--one that counts
unwanted growth in inventories as part of investment--and under a particular valuation of unexpected inventory
accumulation--that which values unwanted inventory accumulation at its cost.
In general, the value of unwanted inventory accumulation can't be equal to its cost--the inventory accumulation is
unwanted and unexpected, meaning that they tried to sell it at a normal price and failed, and it is now sitting in
a corner of a warehouse somewhere. When Fama writes "bailouts and stimulus plans... absorbs savings that would
otherwise go to private investment" he does not think that the rise in public spending is truly useful stuff while
the fall in private investment is a decline in unwanted inventory accumulation--a decline in the amount of stuff
made at high cost that firms could not sell and then must mark down in value.
This matters a lot because whenever unwanted inventories accumulate the next thing that happens is that incomes and
savings drop. (i) NIPA-defined investment is equal to (ii) private savings minus the (iii) government deficit, so
if (iii) changes and (ii) doesn't then (i) must change. But if that change in NIPA-defined investment is driven by
unwanted inventory accumulation or unexpected inventory declines then private savings do change, and do change
quickly and substantially.
Let's tell the story of how:
Suppose that it is Friday, January 2, 2009, and all of a sudden the federal government borrows some money--reducing
savings--and buys some extra stuff. Savings is still equal to investment on January 2: savings went down because
the government ran a bigger deficit but investment also went down because firms sold extra and so their inventories
What happens on Monday, January 5? Over the weekend the firms mark the value of the goods in their remaining
inventory up: inventories are now scarce. They revisit their production plans. Sunday night they call some extra
workers and tell them to show up on Monday--that they are expanding production because they are now short of
inventories. So when Monday rolls around more people are at work. Thus incomes are higher on Monday than they were
on Friday. And in all likelihood savings will be higher as well, for consumers on Monday probably won't raise their
consumption spending by as much as their incomes rose. Maybe on Monday purchases will be back in balance with
production, and there will be no more unwanted inventory changes. Maybe it will take until Monday January 12 before
the change in inventories is back to its desired level. Maybe it will take until the third quarter of 2009, or
perhaps 2010. But when the change in inventories does come back to its wanted level, production, employment,
income, savings, and investment will all be higher than they were on January 1: the stimulus will have worked.
Yet at every point--on every single day--savings are equal to investment according to the accounting conventions of
the National Income and Product Accounts. Fama's premise holds. His conclusion--that stimulus programs cannot
work--doesn't. How can this be? The reason is that his conclusion has nothing at all to do with his premise.
Whether there is complete crowding-out depends on circumstances--on how much of offsetting investment changes are
unwanted and unexpected changes in inventories, and what the consequences of those unwanted and unexpected changes
in inventories are for private savings. But whether there is complete crowding-out or not, savings always equals
investment in the NIPA framework by construction, by definition.
Thus Fama's claim that "'stimulus spending must be financed which means it displaces other current uses of the same
funds..." rests on Fama's implicitly making one of two assumptions: either that stimulus spending does not lead to
any surprise reduction in inventories, or that a surprise fall in inventories does not lead to any change in the
flow of saving. Make either of these assumptions, and Fama's argument goes through--but it is those ancillary
assumptions taht Fama does not explicitly own up to that drive his conclusion, not his stated premise of the truth
of the NIPA savings-investment identity.
But why should you make either assumption? Why would you ever assume that there can't be unwanted growth in
inventories? Why would you ever assume that household incomes and saving do not change whenever firms' stocks of
unwanted inventories grow ever larger?
The answer is that you never would--but that Fama does not know enough national income accounting to know that that
he is making these two ancillary assumptions. He does not understand the identity he deploys as equation (1). He
thinks that "investment" means "growth in the value of the capital stock." He simply does not understand what the
NIPA investment concept is, or that what he thinks of as "investment" is not in general equal to savings.
All of this is part of the undergraduate sophomore economics curriculum. It is gone over again very quickly in
graduate school--for example, David Romer (2006), Advanced Macroeconomics 3e, p. 224:
If one treats goods that a firm produces and then holds as inventories as purchased by the firm, then all
output is purchased by someone. Thus actual expenditure equals the economy's output, Y. In equilibrium, planned
and actual expenditure must be equal. If planned expenditure falls short of actual expenditure, for example,
firms are accumulating unwanted inventories; they will respond by cutting their production...
These mistakes are, literally, elementary ones.
They were elementary when R.G. Hawtrey and the other staffers of the British Treasury made them in the 1920s.
They carry the implication not just that government cannot stimulate or depress the economy, but that no set of
private investment or savings decisions can stimulate or depress the economy either, and thus that there can be no
business cycle fluctuations from any source whatsoever--because every action that shifts savings or investment
simply moves resources from one use to another.
What is extraordinary is that these mistakes are being rederived today, at the end of the 2000s--without any
consciousness of their past or of the refutations of them made by past theory and history.
I think it is time to draw a line in the sand: no more economists who know nothing about the economic history of
the world or the history of economic thought.
I, the ghost of Montagu Norman, have risen from my grave to say this.
Jeebus save us...
Posted at 10:04 PM in Economics, Economics: Macro, Sorting: Front Page, Sorting: Pieces of the Occasion | Permalink
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Stimulus Spending "Skepticism"...
When Republican Houser leader John Boehner wrote:
Republican Leader John Boehner: ATTENTION ECONOMISTS: ARE YOU A STIMULUS SPENDING SKEPTIC? A recent Associated
Press article quoted transition officials for President-elect Obama as saying “[o]nly one outside economist”
contacted by the President-elect’s advisors had “voiced skepticism” about the President-elect’s emerging plans
for an economic “stimulus” spending bill with a price tag as large as $1 trillion, with the vast majority of
that number going to new spending on government programs and projects.
House Republican Leader John Boehner (R-OH) is compiling a list of credentialed American economists who would
like to add their voices to the list of stimulus spending skeptics. If you are an economist who would like to
be added to this list, you can join the list here and provide your comments. Also, please feel free to provide
links to any papers or publications that support or extend upon your comments.
In Stupidest Party Alive I misread Glen Weyl and took him out of context as being opposed to all stimulus plans,
rather than fearing "that the orientation of the Obama plan taking shape at the time, a combination of expansive
public spending, unemployment benefits and indiscriminate tax cuts was unlikely to be properly targeted."
It is my error, for which I apologize.
Posted at 12:42 PM in Economics, Economics: Fiscal Policy, Sorting: Front Page, Sorting: Pieces of the Occasion |
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Spending Stimulus Skeptics: Scraping the Bottom of the Barrel...
Greg Mankiw writes:
More Spending Stimulus Skeptics... Kevin "Dow 36000" Hassett:
We are in the midst of a crisis caused by so many financial institutions borrowing too much money. Somehow,
a critical mass of policy makers now believes that the correct response is for the U.S. government to
borrow too much money...
Can anybody tell me what the argument is going to be? Is it that the U.S. government's borrowing of an extra 6% of
a year's GDP is going to cause the U.S. government to default on its debt? That is the only way that one could try
to make sense of Hassett--and that is an absurd claim.
Shame on Bloomberg for not having dumped Hassett as a columnist before this.
Posted at 02:09 PM in Information: Better Press Corps/Journamalism, Sorting: Front Page, Sorting: Pieces of the
Occasion, Utter Stupidity | Permalink | Comments (17) | TrackBack (0)
The Romer View of Tax and Spending Multipliers Revisited
There appears to be an error in N. Gregory Mankiw's "Economic View" column of January 11, 2009. The error is the
association of Christina Romer with the proposition that the tax multiplier--the effect on GDP of a tax cut--is
twice the spending multiplier. The Romers' article does not distinguish between the two, referring only to the
"substantial multiplier... due to the procyclical behavior of investment" (p. 37 of the working paper version, at
http://tinyurl.com/dl20090111). David Romer in conversation two years ago characterized the paper to me as "hyper-
Keynesian... suggesting very large multipliers..." The Romers believe in a tax multiplier no larger than the
spending multiplier, and they certainly do not believe that a balanced-budget equivalent reduction in taxes and
spending provide any Keynesian stimulus at all.
Mankiw's comparison of the 1.4 estimated spending multiplier from Valerie Ramey's study with the 3.0 estimated tax
multiplier from the Romers' study is inappropriate. The two studies use very different methodologies. They are not
comparable. For example, the Ramey study on the effects of government spending--while a superb contribution to the
literature, and one that I have assigned to my graduate students--does not fully control for the tax increases that
often accompany spending increases. Thus it is very likely to understate the effects of spending increases alone:
her study assesses the impact of the Korean-War military spending increase without taking account of the fact that
it was accompanied by a large tax increase.
What Romer and Romer's study (and their earlier work on monetary policy) shows is not that tax cuts are uniquely
effective, but rather that failing to consider the reasons for policy changes leads to underestimates of the
effects of all types of stimulus. Because these issues of omitted variable bias are likely to be as strong for
spending as for tax changes, the most reasonable interpretation of their paper is that all types of fiscal stimulus
are more potent than conventional estimates would lead us to believe.
It is somewhat puzzling that Mankiw appears to believe that the Romers do think that tax multipliers are larger
than spending multipliers, as they do not, and this is something that he could have very easily checked.
Posted at 01:33 PM in Economics, Economics: Economists, Economics: Fiscal Policy, Sorting: Front Page, Sorting:
Pieces of the Occasion | Permalink | Comments (11) | TrackBack (0)
The Obama Fiscal Boost: A Note
Paul Krugman writes:
Romer and Bernstein on stimulus - Paul Krugman Blog - NYTimes.com: Christina Romer and Jared Bernstein have put
out the official (?) Obama estimates of... the... American Recovery and Reinvestment Plan would accomplish....
Kudos, by the way, to the administration-in-waiting for providing this — it will be a joy to argue policy with
an administration that provides comprehensible, honest reports, not case studies in how to lie with
statistics....[I]t [is] hard to evaluate the reasonableness of the assumed multipliers. But... the estimates
appear to be very close to what I’ve been getting.
[T]hey do estimates of effect in the fourth quarter of 2010, which is roughly when the plan is estimated to
have its maximum effect. So they say the plan would lower unemployment by about 2 percentage points, I said
1.7.... They have the plan raising GDP by 3.7 percent, but that’s at peak; I thought 2.5 percent or so average
over 2 years, again not much difference. So this looks like an estimate from the Obama team itself saying — as
best as I can figure it out — that the plan would close only around a third of the output gap over the next two
One more point: the estimate of what would happen to the economy in the absence of a stimulus plan seems kind
of optimistic. The chart above has unemployment ex-stimulus peaking at 9 percent in the first quarter of
2010... the CBO estimates an average unemployment rate of 9 percent for 2010.... Bottom line: even if I use the
Romer-Bernstein estimates instead of my own — there really isn’t much difference — this plan looks too weak.
If I were in the Obama White-House-to-be right now, I would announce that we would be using CBO numbers as our
baseline for everything, and focus on providing analytical input to CBO so that its numbers are as good as
possible. Doug Elmendorf is honest and reliable and will do his best. And if there is no daylight between the
administration and CBO, that is one fewer way that the David Brookses and the John Boehners and the other bad
actors can confuse the gullible, lazy, and dishonest among reporters and commentators who do so much to degrade the
level of the policy debate.
I agree with Paul that this fiscal boost plan is too small, but I do want to admit that doing this well is harder
than it looks. The tax-cut part does not look terribly effective as a stimulus--it is a step toward compensating
for higher income inequality and a political play to make it more likely that Republicans will lose politically by
trying to block the package rather than a significant boost to employment. Thus I do not think you would want to
make the tax-cut part larger. And it is hard to find a lot of additional spending projects that can be ramped up
quickly and do a lot of good--relatively soon in that endeavor the short-term fiscal multiplier falls below one.
They are trying their best.
Nevertheless, I agree that there best is almost surely not enough. I also believe that conventional monetary policy
is tapped out, and unconventional monetary policy is of doubtful efficacy. So I am in favor of doing something else
on the banking/finance side. My favorite idea right now is that of nationalizing Fannie Mae and Freddie Mac
completely and unleashing them to buy up every single mortgage in the country at market rates. Their ability to
borrow at the Treasury rate means that they should be able to make money by doing this. When they own mortgages
they can renegotiate and refinance them all with the public interest in mind. And as they squeeze banks out of the
mortgage business the fact that banks are looking for yield should push other financial asset prices up--and make
it possible for those businesses that should be expanding to get financing right now on terms that make expansion
So at the moment my preliminary judgment of the Obama fiscal boost is that it is a good first bid, but that the
administration ought to be doing a lot more.
Posted at 01:03 PM in Economics, Economics: Finance, Economics: Macro, Sorting: Front Page, Sorting: Pieces of the
Occasion | Permalink | Comments (10) | TrackBack (0)
Note to Self: The Tax Cut Component of the Obama Fiscal Plan
The tax-cut component of the Obama fiscal boost plan looks much more effective at offsetting rising income
inequality than at creating jobs. It also makes it more difficult for Republicans to vote against the plan as a
whole--and while I wish we had a sane Republican Party that cared about the nation or a weak Republican Party that
could not further disrupt policymaking, we have the Party we have.
TaxVox: the Tax Policy Center blog :: Obama's $300 Billion Tax Cut: Lots of Buck, Not Much Bang: The soon-to-be
Obama Administration floated quite a trial balloon over the weekend: $300 billion in tax cuts for workers and
business over the next couple of years. When you get past the eye-popping number, perhaps the most striking
element is how conventional most of the ideas are. For individuals, they’d include some version of Obama’s
Making Work Pay Credit, a refundable tax credit (aka cash payment) for everyone making roughly $200,000 or
less. Obama aides did not say how this money would be distributed, although they hinted they’d try something
other than the rebates that the Bush White House turned to three times over the past eight years. One idea:
reduced withholding, which would release the funds more slowly than a lump-sum payment would. The research on
the last three rebates suggests that people spent between one-third and one-half of the money within nine
months of the time it got into their pockets. If Obama pumped $150 billion into these tax cuts and 40 percent,
or $60 billion, got spent, the impact on the U.S.’s $14 trillion economy would be real, though modest.
On the business side, Obama aides leaked three ideas. The first: extending bonus depreciation, another Bush
measure that would allow companies to write-off the cost of equipment faster. The second: giving companies
immediate refunds by letting them use using last year’s losses to reduce prior year tax liabilities. Idea #3:
giving businesses a refundable tax credit for each new worker they hire or even each employee they don’t lay
off. The net operating loss idea makes some sense. But other than trying to buy votes from pro-business Capitol
Hill Republicans, it is hard to see what the other two schemes would accomplish. Bonus depreciation in its many
incarnations has been tried a half-dozen times over the past four decades and its benefits are, shall we say,
hard to find. It won't help companies with losses (most of them, these days), or non-profits. A year ago, while
both were at The Brookings Institution and TPC, Obama advisor Jason Furman and CBO director-designate Doug
Elmendorf wrote of the 2001-2003 versions, “bonus depreciation for business investment did not seem to be very
effective in spurring economic activity”...
Posted at 11:34 AM in Economics, Economics: Fiscal Policy, Politics, Sorting: Front Page, Sorting: Pieces of the
Occasion | Permalink | Comments (8) | TrackBack (0)
Paul Krugman Fears Deflation, and Wants a Bigger Stimulus
Risks of Deflation/a>: CBO is currently projecting an output shortfall from the current slump comparable to the
slump of the early 1980s... if you compare the CBO’s projections of unemployment from 2008 through 2012 with
its estimate of the natural rate, we’re looking at cumulative excess unemployment of 13.9 point-years; that
compares with 13.7 point years from 1980 through 1986.... Now here’s the thing: the slump of the early 1980s
produced the Great Disinflation, which brought the core inflation rate down from about 10 to about 4. This
time, however, we entered the slump with a core inflation rate of about 2.5 percent. If we experienced a
disinflation comparable to that of the 1980s, that would mean ending up with deflation at a rate of -3.5
So tell me why we aren’t looking at a very large risk of getting into a deflationary trap, in which falling
prices make consumers and businesses even less willing to spend. Tell me why this risk wouldn’t remain high,
though lower, even with the Obama plan, which as far as I can tell is expected to reduce cumulative excess
unemployment by about a third.
I want a bigger fiscal policy boost to the economy as well.
Posted at 11:31 AM in Economics, Economics: Macro, Sorting: Front Page, Sorting: Pieces of the Occasion | Permalink
| Comments (5) | TrackBack (0)
Stupidest Party AliveTM
People who have endorsed the Republican House caucus's objections to the stimulus package:
Donald Luskin, Chief Investment Officer, Trend Macrolytics LLC, Stupidest Man Alive EmeritusTM: "Government
spending does not create incentives for labor, innovation and investment. Instead of spending $1 trillion in
Washington, let Washington forgive $1 trillion in tax revenues to create incentives for millions of individuals
and firms to get the economy going again, one dollar at a time."
People who have not the Republican House caucus's objections to the stimulus package:
Eddie Lazear, Chair, President's Council of Economic Advisers (George W. Bush)
Matthew Slaughter, Member, President's Council of Economic Advisers (George W. Bush)
Katherine Baicker, Member, President's Council of Economic Advisers (George W. Bush)
Ben Bernanke, Chair, President's Council of Economic Advisers (George W. Bush)
Harvey Rosen, Chair, President's Council of Economic Advisers (George W. Bush)
Kristen Forbes, Member, President's Council of Economic Advisers (George W. Bush)
N. Gregory Mankiw, Chair, President's Council of Economic Advisers (George W. Bush)
Randall Kroszner, Member, President's Council of Economic Advisers (George W. Bush)
Mark McClellan, Member, President's Council of Economic Advisers (George W. Bush)
R. Glenn Hubbard, Chair, President's Council of Economic Advisers (George W. Bush)
Paul Wonnacott, Member, President's Council of Economic Advisers (George H. W. Bush)
Richard Schmalensee, Member, President's Council of Economic Advisers (George H. W. Bush)
John Taylor, Member, President's Council of Economic Advisers (George H. W. Bush)
Michael Boskin, Chair, President's Council of Economic Advisers (George H. W. Bush)
Michael Mussa, Member, President's Council of Economic Advisers (Ronald Reagan)
Thomas Moore, Member, President's Council of Economic n SpriyAdvisers (Ronald Reagan)
Beryl Sprinkel, Chair, President's Council of Economic Advisers (Ronald Reagan)
William Poole, Member, President's Council of Economic Advisers (Ronald Reagan)
Martin Feldstein, Chair, President's Council of Economic Advisers (Ronald Reagan)
Jerry Jordan, Member, President's Council of Economic Advisers (Ronald Reagan)
William Niskanen, Member, President's Council of Economic Advisers (Ronald Reagan)
Murray Weidenbaum, Chair, President's Council of Economic Advisers (Ronald Reagan)
Burton Malkiel, Member, President's Council of Economic Advisers (Gerald Ford)
Paul MacAvoy, Member, President's Council of Economic Advisers (Gerald Ford)
Alan Greenspan, Chair, President's Council of Economic Advisers (Gerald Ford)
Gary Seevers, Member, President's Council of Economic Advisers (Gerald Ford)
Marina von Neumann Whitman, Member, President's Council of Economic Advisers (Richard Nixon)
Paul McCracken, Member, President's Council of Economic Advisers (Richard Nixon)
In fact, no current or former member of the President's Council of Economic Advisers--Democrat or Republican,
living or dead, sane or insane--has signed up for the Republican House caucus's list of economists opposed to the
stimulus package. None. Zero. Nada. Sifr. Efes. Wala sero. Kosong sifar. 'Ole. Knin. Pujyam. Mann. Dim. Nocht.
Null. Meden. Hitotsu. Sifuri. Ling. Sunya. Mwac. Ataqan. Saquui. Hun. Illaq. Wanzi. Wanzi. Pagh. Na. Uqua.
That should tell you something about today's Republican Party.
Other ethics-free Republican hacks, whose organizations share in their burning of their own credibility:
Michael Cannon, Cato Institute: "The only way Congress can spend money is to extract it from the private sector
– either by taxing it, borrowing it, or seignorage. The question then becomes: will Congress spend that money
more wisely than the private sector would have spent it? The answer appears to be no. Congress typically spends
according to its political priorities, not economic priorities."
Antony Davies, Associate Professor of Economics, Duquesne University: "It is time for voters to wake up to the
fact that government cannot create jobs. It can only shift jobs from one part of the economy to the other. It
is entrepreneurs who create jobs, and it is consumers who judge whether those jobs are the best jobs to be
created. The government contributes best by establishing a rule of law and protection of property rights that
allows entrepreneurs and consumers to act in their best interests."
Joseph Zoric , Associate Professor of Economics, Franciscan University of Steubenville: "The stimulus plan will
most probably turn quickly into pork spending. Marginal rate tax cuts would be a much more effective way to
stimulate demand along with cuts in the capital gains and corporate tax rates. Evidence shows that marginal tax
cut multipliers are much higher than spending multipliers. In addition the Fed is still not out of ammunition."
Edward Lopez, Associate Professor of Law and Economics, San Jose State University: "Fiscal stimulus may have
symbolic value and certainly does provide an expedient for distributive politics, but there is NO evidence that
it contributes to GDP or economic growth more broadly."
Justin Ross, Assistant Professor of Economics, School of Public and Environmental Affairs, Indiana University:
"Empirical evidence overwhelmingly rejects federal government deficit spending as the best method for
stimulating the economy, and is generally unsupportive of it having any stimulus effect at all."
Steven Horwitz, Charles A. Dana Professor of Economics, St. Lawrence University: "The stimulus plans assume
consumption is the source of economic growth. It is not. It is the consequence of said growth. The ‘stimulus’
is a redistribution of spending, at best, and will do little to help. The next Administration should avoid
large scale programs and experimentation and allow the marketplace to correct the errors made by the last 8
years of misguided intervention."
Richard Wagner, Professor of Economics, George Mason University: "Any so-called stimulus program is a ruse. The
government can increase its spending only by reducing private spending equivalently. Whether government
finances its added spending by increasing taxes, by borrowing, or by inflating the currency, the added spending
will be offset by reduced private spending. Furthermore, private spending is generally more efficient than the
government spending that would replace it because people act more carefully when they spend their own money
than when they spend other people's money."
Stephen Entin, President & Executive Director, Institute for Research on the Economics of Taxation: "Want to
grow the economy without inflation? Cut marginal tax rates, slash the corporate rate, expense investment in the
first year (instead of depreciation), keep tax rates low on dividends and capital gains, and repeal the death
tax. Have the Federal Reserve focus on price stability and a sound dollar, and on not generating a monetary
roller coaster. (That, in part, is what caused the housing and commodities bubbles.) Rein in government
spending to pay for the tax cuts, and trim senseless regulation."
Gary Wolfram, William Simon Professor of Economics, Hillsdale College: "Rather than old style Keynesianism we
should reduce the corporate income tax substantially. The problem is not lack of demand, but rather a lack of
investment. By reducing the corporate income tax, among the highest in the industrialized world, we will
increase the incentive for companies to invest in new equipment, technology, research and development, and
buildings. This will increase productivity in the long run, leading to higher GDP and higher wages.”
Lawrence Franko, Retired Professor, University of Massachusetts Boston, College of Management: "Government
‘infrastructure spending stimulus’ programs in Japan during the 1990s produced no stimulus, but rather a vast
overhang of government debt. Bridges, tunnels, roads, and trains to nowhere stimulate nothing. It is
productivity growth that counts, and that comes mainly from the private sector – which is why tax cuts have
always been a surer way to economic recovery.
Michael Sykuta, Associate Professor, University of Missouri – Columbia: "Government intervention and ‘stimulus’
in the housing market is largely responsible for the current economic crisis. History has shown that the Obama
team’s proposed ‘stimulus’ is not only going to have little to no effect in the short run, but will create a
larger bureaucratic structure, lead to tremendous investments in unproductive political lobbying among
‘stimulus project’ wannabes, and dissuade/delay private investment, recovery and growth."
David Laband, Professor of Economics and Policy, Auburn University: "Our economy as a whole will [no] benefit
from taking money from current or future taxpayers to support a government spending spree. No doubt, certain
interest groups will gain from feeding at the public sector trough. But losers surely will outnumber winners by
a large margin. Our economy as a whole will benefit from Congress lowering taxes and letting Americans decide
for themselves what is worth spending their hard-earned dollars on."
Howard Baetjer, Lecturer, Dept. of Economics, Towson University: "A government-spending ‘stimulus’ is a very
bad idea. Because government can spend only what it has taxed or borrowed away from the public, it creates no
new demand but merely redirects it. Recovery depends on profit and loss discipline and public confidence that
the basic rules underlying free markets will be followed. The latter is hurt by government interventions such
Glen Weyl, Junior Fellow at the Society of Fellows and Post-Doctoral Fellow in the Department of Economics,
Harvard University: "Nothing about a recession justifies larger government. If we are worried about too few
jobs, it makes sense to subsidize private employment (for example, by temporarily lowering payroll taxes or
creating a new tax subsidy for new hires)." UPDATED: THIS IS OUT OF CONTEXT AND DOESN'T BELONG HERE: GLEN WEYL
IS MAKING A MUCH MORE SOPHISTICATED POINT
Henry Thompson, Professor, Auburn University: "The current recession was caused by government fiddling with the
mortgage market and the moral hazard created by the illusion of government monitoring of financial markets.
Increased government involvement in the economy is not the solution."
Gene Smiley, Emeritus Professor of Economics, Marquette University: "An ‘economic stimulus’ program will do
nothing to correct the serious price and resource misallocations that currently exist and are stopping the
economy from moving back toward ‘full-employment.’ In fact, they will likely retard the recovery. They will
divert resources from the private sector to the government sector moving us further away from a free-enterprise
Stacie Beck, Professor, University of Delaware: "A spending stimulus will only delay the needed restructuring
of the U.S. economy to remain internationally competitive. Tax cuts will facilitate that restructuring far
better than spending and job creation by the government."
Steve Entin's presence on this list is sad. He was an economist once upon a time...
Posted at 11:20 AM in Economics, Economics: Macro, Moral Responsibility, Sorting: Front Page, Sorting: Pieces of
the Occasion, Utter Stupidity | Permalink | Comments (14) | TrackBack (0)
DeLong: What Has Happened to Milton Friedman's Chicago School? DRAFT
6th Singapore Economic Review Public Lecture: